<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934


                   For the fiscal year ended December 31, 2000

                          Commission file number 1-4373

                            THREE-FIVE SYSTEMS, INC.
             (Exact Name of Registrant as Specified in Its Charter)

                 Delaware                             86-0654102
        (State or Other Jurisdiction         I.R.S. Employer Identification No.)
        of Incorporation or Organization)

           1600 North Desert Drive, Tempe, Arizona          85281
          (Address of Principal Executive Offices)        (Zip Code)

                                 (602) 389-8600
              (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:

        Title of Each Class            Name of Each Exchange on Which Registered

Common Stock, par value $.01 per share          New York Stock Exchange

     Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

     The aggregate market value of Common Stock held by nonaffiliates of the
registrant (21,051,659 shares) based on the closing price of the registrant's
Common Stock as reported on the New York Stock Exchange on March 12, 2001, was
$322,721,932. For purposes of this computation, all officers, directors, and 10%
beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such officers,
directors, or 10% beneficial owners are, in fact, affiliates of the registrant.

     As of March 12, 2001, there were outstanding 21,421,165 shares of the
registrant's Common Stock, par value $.01 per share.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant's definitive Proxy Statement for the 2001 Annual
Meeting of Shareholders are incorporated by reference into Part III of this Form
10-K.
<PAGE>   2
                            THREE-FIVE SYSTEMS, INC.

                           ANNUAL REPORT ON FORM 10-K

                      FOR THE YEAR ENDED DECEMBER 31, 2000

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                          PAGE
                                     PART I
<S>           <C>                                                                         <C>
ITEM 1.       BUSINESS..................................................................    1
ITEM 2.       PROPERTIES................................................................   24
ITEM 3.       LEGAL PROCEEDINGS.........................................................   24
ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................   24

                                     PART II

ITEM 5.       MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
                  MATTERS...............................................................   25
ITEM 6.       SELECTED FINANCIAL DATA...................................................   26
ITEM 7.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                  RESULTS OF OPERATIONS.................................................   27
ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................   33
ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...............................   34
ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                  AND FINANCIAL DISCLOSURE..............................................   34

                                    PART III

ITEM 10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................   34
ITEM 11.      EXECUTIVE COMPENSATION....................................................   34
ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............   35
ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................   35

                                     PART IV

ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K..........   36

SIGNATURES..............................................................................   38

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS..............................................  F-1
</TABLE>


                 STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

     The statements contained in this report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of applicable
securities laws. Forward-looking statements include statements regarding our
"expectations," "anticipation," "intentions," "beliefs," or "strategies"
regarding the future. Forward-looking statements also include statements
regarding revenue, margins, expenses, and earnings analysis for fiscal 2001 and
thereafter; technological innovations; future products or product development;
our product development strategies; potential acquisitions or strategic
alliances; the success of particular product or marketing programs; the amounts
of revenue generated as a result of sales to significant customers; and
liquidity and anticipated cash needs and availability. All forward-looking
statements included in this report are based on information available to us as
of the filing date of this report, and we assume no obligation to update any
such forward-looking statements. Our actual results could differ materially from
the forward-looking statements. Among the factors that could cause actual
results to differ materially are the factors discussed in Item 1, "Business -
Special Considerations."


                                       i
<PAGE>   3
                                     PART I

ITEM 1.            BUSINESS

INTRODUCTION

     We design and manufacture display modules for use in the end products of
original equipment manufacturers, or OEMs. We currently specialize in custom
liquid crystal display, or LCD, components and technology. We collaborate
closely with our customers in providing our design and manufacturing services.
Our LCD modules are used in mobile handsets and other wireless communication
devices as well as in the data collection, medical electronics, and other
commercial and consumer marketplaces. In addition to our traditional LCD module
business, we are pursuing the commercialization of our liquid crystal on
silicon, or LCoS, microdisplays following substantial research and development
over the past three years. We market our services in North America, Europe, and
Asia primarily through a direct technical sales force. Motorola is our largest
customer.

INDUSTRY OVERVIEW

Liquid Crystal Displays

     Prior to the introduction of LCDs in the 1970s, most commonly used displays
and indicators had substantial limitations as to their use, especially in terms
of size, life, and power consumption. LCDs were developed in response to these
limitations, especially the demand for greater information content and less
power consumption than was possible using light emitting diode, or LED,
technology. LCDs, sometimes called flat panel displays, provide high-information
content displays at competitive prices. LCDs now appear in products throughout
the communications, office automation, industrial, medical, and commercial
electronics industries. LCDs are one of the fastest growing of the established
display industry segments, primarily because of their widespread application in
mobile communications devices, a fast-growing segment of the electronics
industry.

     An LCD modifies light that passes through or is reflected by it, rather
than emitting light like an LED. An LCD generally consists of a layer of liquid
crystalline material suspended between two glass plates. The liquid crystals
align themselves in a predictable manner when stimulated electrically. The
alignment produces a visual representation of the desired information. LCDs can
display information in black and white or in a wide range of color combinations.
LCD displays consist of a matrix of dots, called pixels, which are arranged in
rows and columns that can be selectively energized to form letters or pictures.
A principal advantage of LCDs over other display technologies, such as LEDs, is
the ability to include thousands or even millions of pixels in a single display,
which allows for greater information content.

     There are two types of LCDs, active matrix and passive matrix. Active
matrix LCD displays are relatively complex devices that require manufacturing
operations involving very large capital investments. Active matrix LCD displays
are used in larger, high-information content applications, such as laptop
computers. Passive matrix LCD displays are less complex and less expensive to
manufacture. Passive matrix LCD displays are used in such applications as mobile
handsets, pagers, office equipment, data collection terminals, point-of-sale
equipment, medical devices, transportation instrumentation, and industrial
instruments and controls.

The Custom Passive LCD Market

     We estimate that the worldwide market for passive LCD modules was
approximately $5 billion in 2000. This market includes displays used in mobile
handsets and other communications equipment, business, industrial and
transportation equipment, and computer and consumer products. Mobile handsets
represent the third largest market for LCD modules. According to Stanford
Resources, the worldwide market for LCDs in mobile handsets has grown from an
estimated 165 million units in 1998 to 281 million units in 1999. Industry
sources estimate that mobile handset production was slightly over 400 million
units in 2000. Additional fast growing markets for LCD display modules include
pagers, personal digital assistants, or PDAs, and palm top computers.

     The increasing complexity and functionality of handheld products, such as
wireless computing devices, require OEMs to increase the visual performance and
information content of the displays incorporated into their products. At the
same time, the market continues to demand that OEMs incorporate displays with
reduced power


                                       1
<PAGE>   4
requirements and lower costs. Custom passive LCDs address these requirements for
high performance, increased information content, low power, and low cost.

     OEMs also seek ways to differentiate their products from the products of
their competitors. Custom-designed display modules provide OEMs a cost-effective
means to achieve this differentiation. In designing its product, an OEM must
determine whether to use standard "off-the-shelf" display modules, to design its
own custom display modules for production by a custom display manufacturer, or
to enter into arrangements with a third party for custom display design and
production. In making a decision to engage third parties for custom design and
production, OEMs recognize that standard "off-the-shelf" displays make it more
difficult to differentiate their products from those of their competitors. In
considering whether to design their own display modules, OEMs often recognize
that their greatest strengths consist of consumer brand name recognition, market
research and product development expertise, and highly developed sales and
distribution channels. Advanced design and manufacturing processes require
increasing investments for research and development, personnel, and equipment.
Competitive market conditions require a shorter period of time from product
conception to delivery, product differentiation, improved product user
friendliness, and continually enhanced product performance and reduced product
cost during the life cycle of the product. As a result of these factors and
increasingly sophisticated and complex technology, it has become more difficult
for even the leading OEMs to maintain the necessary technology, expertise,
personnel, and equipment to design and produce internally all of the various
components necessary for their products. As a result, there has been a trend
toward outsourcing the design and production of components such as display
modules.

     In addition to design and production, OEMs have increased their use of
third-party suppliers to add additional components to their products. This
permits the integration of more of the manufacturing steps into fewer locations.
This trend toward integration and outsourcing decreases the number of suppliers
necessary to produce a final product and results in lower costs.

The Emerging Microdisplay Market

     Market trends demand high-information, power-efficient displays with
increasing functionality and smaller sizes at relatively low costs.
Microdisplays based on liquid crystal on silicon technology provide a response
to those demands.

     Liquid crystal on silicon microdisplays are a form of LCD in which liquid
crystalline material is suspended between a glass plate and a silicon backplane
rather than between two glass plates. The silicon backplane, essentially an
integrated circuit, provides drive signals for each pixel element of the display
as well as logic functions, such as serial to parallel conversion and data
storage. Because silicon integrated circuits, a highly developed technology,
form the basis of these displays, liquid crystal on silicon technology permits a
very high-information, high-performance display in a small size and at a
relatively low cost.

     Microdisplays are no larger than a thumbnail, but contain all of the
information appearing on a high-resolution personal computer screen. The tiny
image on a microdisplay can be projected onto a screen or other surface for
individual or group viewing or used in a portable application that is viewed
through a magnifying device similar to a viewfinder. Various types of projector
applications represent the most common current use of microdisplays. Projectors
can cast the information on a distant large screen, as in audio-visual front
projectors, or shine the image through a translucent screen, as in rear
projectors. Potential initial microdisplay applications include use in business
projection equipment and computer monitors. Other potential applications include
digital and high-definition televisions and a wide variety of portable devices,
such as wireless Internet access devices, mobile handsets, pagers, and PDAs as
well as in wearable computing equipment using head-mounted displays, which allow
hands-free access to large amounts of information.

     A well-developed front projector market currently exists. These products
are typically referred to as audio-visual projectors and are generally fixed or
portable products used in business applications. Most front projectors currently
use transmissive polysilicon microdisplay technology or digital micro-mirror
devices, also called DMDs. Reflective liquid crystal on silicon technology,
however, is expected to provide more information at a lower cost.

     Emerging market segments are beginning to develop for large,
cost-effective, higher-resolution computer monitors and television screens.
Current display technologies for computer monitors and digital and high-
definition televisions encounter serious barriers related to cost, resolution,
and dimensions when used for high-resolution large


                                       2
<PAGE>   5
screens. Many companies are considering the incorporation of microdisplays into
large, high-resolution screens to enable affordable display solutions.

     Significant development efforts are currently being directed to portable
microdisplays as a potential method for delivering high-information content at
low cost and with low power consumption in mobile, hand-held communication
devices. It is widely assumed that converged voice and data communication
devices have the potential to become a new class of products in mobile
communications, probably integrated with PDA functions, such as phonebooks and
calendars. In concept, the functions of the telephone, e-mail, pagers, PDAs, and
the Internet are expected to become integrated. Delivery of high-information
content over the Internet on a small, direct-view display, however, presents
difficult technological challenges. Portable microdisplays used with a
viewfinder offer a potential solution because they can deliver as much
information as a computer monitor in a very small, lightweight, and
power-efficient package.

     The portable microdisplay market is just beginning to develop. Market
potential currently is uncertain and is limited by such factors as the
availability of sufficient wireless communication bandwidth, the uncertainty of
customer acceptance, and the possibility of alternative technologies.
Nevertheless, many major vendors of mobile handsets, pagers, and PDAs have
prototype programs underway to develop new converged mobile communication
products with large information content at low cost, and many of these vendors
are beginning to assess portable microdisplays for use in these products.

THE THREE-FIVE APPROACH

     We seek to provide our customers with high-performance, information-rich,
low-power consumption displays that have competitive advantages in terms of
size, cost, and product differentiation. To accomplish this goal, our research
and development activities focus on technological developments intended to meet
the current and future requirements of our customers. We add value for our
customers through our ability to integrate the design and production process,
which reduces the time between product conception and market introduction. Our
emphasis on customization and technological leadership has positioned us to
develop new custom product solutions for our customers as they seek displays
with more information content at lower cost.

     Our custom product solutions provide OEMs with the following benefits:

     -    access to specialized design and manufacturing technology and
          expertise;

     -    accelerated design process and reduced design and manufacturing costs
          through the use of our specialized personnel, equipment, and
          facilities;

     -    reduced reliance on multiple suppliers for components and integration
          of their production processes; and

     -    the ability to concentrate their own resources on the design,
          production, and distribution of their core products.

     By eliminating the duplication and overlap of investment and resources, we
and our OEM customers are able to work together and grow at a faster rate than
would otherwise be possible. We concentrate on the development of our display
technologies and their applications to products, while our customers devote time
and resources on market development for these products.

     Our historical target market consists of high-end monochrome passive matrix
LCD display modules of 1/4 VGA (320 x 240 pixels) or less resolution, primarily
those having smaller than three-inch diagonal screen sizes. We do not address
low-end LCD display markets, such as watches and calculators. Our target market
for LCoS microdisplays consists of displays of SVGA (800 x 600 pixels) or higher
resolution.

STRATEGY

     Our strategy is to enhance our position as a leading worldwide supplier of
custom-designed and manufactured displays for application in various high-growth
segments of the electronics industry. Key elements of our strategy include the
following:


                                       3
<PAGE>   6
Target Leading Customers in High-Growth Industries

     We identify industries that we believe have the greatest long-term
potential for growth. We recognize that our growth and development is closely
aligned with the growth and development of the industries we serve. Current
targeted industries include mobile handsets and other wireless communication,
data collection, office automation, medical equipment, and other commercial and
consumer marketplace products.

     Within an industry, we target leading companies that we believe would
benefit from our design and manufacturing services. Targeted customers typically
are Fortune 1000 manufacturing companies whose products require display devices.
Our sales and engineering staffs then attempt to demonstrate the benefits that
the potential customer would derive by outsourcing to us the design and
production of display devices required in their products.

     Once we establish a relationship with a new customer, we endeavor to
develop new programs for other product groups within the customer's business.
For this reason, we specifically target customers with multiple divisions or
product lines.

Expand Customer Base

     We intend to intensify our efforts to expand our customer base. We also
plan to target specialized markets that have substantial volume requirements. We
will continue to seek opportunities in growing and emerging markets, both in the
United States and internationally.

Establish Close Relationships with Customers

     We seek to establish strong and long-lasting customer relationships through
our fundamental business practice, which we refer to as "customer partnering."
Customer partnering involves aligning our prospects with those of our customers
and seeking to make our engineering and production staffs seamless extensions of
the product design and production departments of our customers. This includes
our engineers spending a significant portion of their time assisting customers
with their own research and development efforts at their facilities. In
addition, our customers' engineers spend a significant amount of time conducting
research and development in our facilities.

     We stress product solutions for our customers' products. We view each
customer's new product as our own and take pride in creating and implementing
innovative engineering solutions that differentiate the customer's product from
competitive products. In connection with this philosophy, we have positioned
ourselves to provide a rapid response to our customers and their worldwide
operations.

     To achieve our customer partnering goal, we emphasize corporate cultures,
customs, and communications that complement those of our customers. A thorough
understanding of our customers' products and business goals enables us to
anticipate customer needs and to develop new design and production solutions for
their products.

     We continually attempt to enhance the competitive position of our customers
by providing them with innovative, distinctive, and high-quality display devices
on a timely and cost-effective basis. To do so, we work continually to improve
our productivity, lower our costs, and speed the delivery of our product
solutions. We endeavor to streamline the entire design through delivery process
by maintaining an ongoing engineering and manufacturing improvement effort.

     We continue to provide customer support after product design has been
completed and production has been commenced. Through such follow-on activity, we
conduct quality enhancement and cost-reduction efforts to maintain the
competitiveness of our customers' products.

Provide Advanced Custom Design and Manufacturing Services

     We seek to design, prototype, and manufacture, on a timely and
cost-effective basis, a wide range of innovative, distinctive, and high-quality
display devices for operational control and information display functions
required in the end products of OEMs. Our design processes utilize advanced
computer-aided design software to provide custom solutions for customers'
products in time frames and on cost bases that we believe are substantially
shorter and lower-priced than industry norms.


                                       4
<PAGE>   7
     We operate our highly automated, high-volume LCD manufacturing line in
Arizona to produce the majority of our LCDs. We utilize advanced, flexible
manufacturing systems for high-volume module assembly in Manila and Beijing. We
believe our three manufacturing facilities provide us with a competitive
advantage in meeting the custom LCD needs of our customers. We anticipate that
our ability to design, prototype, and manufacture product solutions will be
enhanced by the expansion of our engineering personnel, our increased design
capacity, and our ability to meet our LCD requirements. We continue to increase
our production personnel and add sophisticated manufacturing equipment to meet
expanding capacity requirements. We will continue to explore the most advanced
and cost-efficient production methods for each product solution.

Exceed Customer Requirements Through Speed and Efficiency

     We emphasize innovative design and manufacturing techniques to improve the
speed, efficiency, and performance of our design and manufacturing services.
This enables our customers to address the pressure to reduce the lead times for
market introduction of their products. As part of our development process, we
continually improve and modify our design and manufacturing processes, controls,
and methodology in an effort to support our customers' requirements.

Leverage Research, Development, and Engineering

     We continually strive to develop and acquire new technologies and utilize
technological developments in order to provide practical solutions for our
customers. We conduct an active research and development program designed to

     -    continually improve our products and create new products;

     -    increase our efficiency;

     -    reduce our costs;

     -    improve the speed, efficiency, and performance of our design and
          manufacturing services;

     -    develop new design and manufacturing processes and techniques; and

     -    enhance the quality, cost-effectiveness, and value of our services.

     We plan to expand our research and development efforts through increased
expenditures and the hiring of additional personnel to meet the expectations of
our customers and to satisfy our goal to design and produce the most advanced
product solutions on a timely and cost-effective basis. New technologies include
our LCoS microdisplays, which address the increased demands for high-information
displays in a small size and at a relatively low cost. In addition, we currently
are exploring the development and expansion of existing LCD technologies as well
as new technologies, such as sunlight readable LCDs, color LCDs, plastic LCDs,
bi-stable LCDs, graphics and color graphics, organic and polymer light emitting
displays, and pixel-related display technologies.

PRODUCTS AND SERVICES

     We currently engage in the design and manufacture of LCD display modules
and the development and commercialization of manufacturing technologies for use
in various products of OEMs.

LCD Display Modules and Services

     We currently emphasize custom designed LCD display modules. A manufacturer
of a complete system or product requiring a specific type of visual display,
such as a mobile handset, medical instrument, business machine, or hand-held
data collection device, represents a typical buyer for a custom LCD display
module. For each custom display module, we work directly with our customer to
develop and produce the original design and to manufacture the display module in
accordance with the customer's specifications. At a minimum, each module
includes an LCD, a custom LCD driver, and a flexible connector. We also provide
value-added services by assembling additional components onto the module, such
as keypads, microphones, speakers, light guides, and optics. In 2000, LCD custom
display modules and related components accounted for approximately 97.7% of our
net sales.


                                       5
<PAGE>   8
     We have developed a sophisticated design process to meet the specific needs
of our customers' applications. Each design project normally involves a
cross-functional team of our engineers who are assigned to a customer program.
The team consults with the customer's engineers throughout the design, prototype
development, and manufacturing process. We continue to supply value-added
engineering support after the design solution has been developed and integrated
into the manufacturing process in an ongoing effort to provide customers with
product performance enhancements and cost-reduction opportunities.

     The difficulties in developing a custom LCD module include unclear customer
expectations, evolving customer requirements, and changing customer end-product
specifications. These factors result in lengthy lead times for market
introduction of customers' products. To overcome the traditional obstacles
involved in custom design and development, we have developed the four phase
program development process described below. We combine our program development
process with our philosophy of being a "seamless extension of our customer."
This results in a very flexible, responsive, accurate, and fast development
cycle that enables our customers to introduce their products into the market
rapidly. Our program development process consists of the following phases:

     -    Feasibility and concept phase. We work closely with our customer to
          understand its requirements. Customer input varies from rough sketches
          to detailed specifications. Experienced LCD module design engineers
          work to develop conceptual solutions to customer requirements that
          include both design and cost parameters.

     -    Prototype phase. We conduct a design review with the customer;
          complete at our Arizona facility a proposed design, including the
          electrical, mechanical, and optical features of the LCD display
          module; and deliver a prototype to the customer.

     -    Pilot phase. We perform a thorough design review with our customer,
          involving an analysis of performance, cost, and volume production
          considerations. A successful pilot phase results in the completion of
          any design changes, the ordering of the tooling required for
          production, and the delivery of manufacturing samples. We generally
          conduct the pilot phase primarily in Manila.

     -    High-volume production phase. We complete any required changes in the
          manufacturing process, receive necessary tooling, and commence
          high-volume production. The production takes place either in Manila or
          Beijing.

New Proprietary Displays

     We are pursuing several new technology initiatives in our LCD module
business, including sunlight readable LCDs (Liquid Crystal intense Display, or
LCiD(R)), grey scale LCDs (Liquid Crystal active Display, or LCaD(R)), color STN
LCDs, and color TFT LCDs. We are also beginning the research and development
activities in new technologies like organic light emitting displays.

LCoS Microdisplays

     The display market demands continually greater information content at
reduced prices. In response to these demands, we are pursuing the
commercialization of our liquid crystal on silicon, or LCoS, microdisplays
following three years of extensive research and development activities. Our LCoS
technology provides very high-information content in a small size and at an
expected relatively low cost. The information presented by these displays is
magnified for view, generally either in a projector or in a viewfinder. We
believe that the inherent capability of our LCoS technology provides a
cost-effective solution to increased information demands.

     Our current plan for the development of our LCoS microdisplay business is
to respond in an efficient manner to industry developments and changes, to
develop a dedicated organization infrastructure, and to develop or lead the
market to a common LCoS module platform. To meet our business objective of
becoming the leading supplier of microdisplay visual systems, we must rapidly
commercialize LCoS microdisplay technology on a cost-effective basis. This
requires us to focus on common LCoS module platforms that provide economies of
scale, rapid time to market, and broad market penetration. Specifically, our
strategy calls for a business preparation phase and a business growth phase. In
2000, we were in the preparation phase in which we were emphasizing research,
development, and licensing opportunities to expand our technology portfolio,
design engineering of LCoS products


                                       6
<PAGE>   9
for a significant number of OEMs, and establishing an organization
infrastructure. The business growth phase, which is anticipated to begin in
2001, calls for resources to be deployed primarily in high-volume manufacturing,
marketing, sales, and business development.

     We are developing a broad range of LCoS microdisplay products to offer
customers. The table below sets forth various resolutions with pixel count, or
the number of color dots on a screen, and potential uses for our LCoS
microdisplays. We currently have multiple LCoS applications, which we have
prototyped for customer evaluation. We are focussing on products with the
capability to produce all of the following resolutions:



RESOLUTION       PIXEL COUNT                   APPLICATIONS
----------       -----------                   ------------
SVGA               480,000       Hand-held devices, such as PDAs or mobile
                                 handsets, and head mounted displays or wearable
                                 computers

XGA                780,000       High-end portable audio-visual projectors

SXGA             1,300,000       Low-end portable audio-visual projectors,
                                 rear-projection monitors, and high-definition
                                 television

HDTV             2,000,000       High-definition digital television

     We believe that the initial markets for our LCoS microdisplay products will
be in front projectors, monitors, and digital and high-definition television
sets. Currently, the front projector, rear projection, and digital and
high-definition television markets are being served by active matrix polysilicon
microdisplays and DMD microdisplays. Polysilicon microdisplays are manufactured
by several large Japanese companies. These products are incapable of producing
cost-effective resolutions above XGA without the further expense of adding
special optics and are generally more expensive than anticipated costs for LCoS
microdisplays. DMD microdisplays are a proprietary product of Texas Instruments.
Although DMDs have no inherent resolution limitations, they are relatively
expensive to manufacture, especially at higher resolutions. The expected
relatively low cost for LCoS microdisplays makes them more suitable for
competitive consumer marketplaces, such as portable business projectors,
monitors, and digital and high-definition televisions.

     We believe another market for LCoS microdisplay products will be converged
wireless products requiring high-information content displays for e-mail and
access to the Internet. Use of an LCoS microdisplay in a viewfinder application
would enable a person to carry a portable device capable of delivering the same
SVGA resolution as on the person's desktop or laptop computer. This has the
potential to allow portable access to the Internet and critical information,
such as calendars, maps, e-mail, and documentation, in a handheld product. The
high resolution of the device would avoid scrolling or time-consuming text
conversions in accessing the World Wide Web for needed information.

     We plan to offer a range of LCoS product solutions with different levels of
integration from individual light valves to fully integrated displays. By
adopting a modular approach to configuring and selling our LCoS microdisplays,
we will have the opportunity to price our products on a value-added basis and to
rapidly introduce new LCoS products. In addition, we have been working with
optical companies that are interested in developing optical light engines for
sale to OEMs that manufacture monitors and televisions. A light engine consists
of a lens, color management system, lamp, and microdisplay. LCoS microdisplays
require different optics than those employed when using transmissive polysilicon
microdisplays.



                                       7
<PAGE>   10
     We will have undertaken extensive development efforts before the first sale
of LCoS products, and we expect to incur substantial losses in the microdisplay
business until the volume production of LCoS microdisplays occurs. We currently
expect volume production to commence in 2001.

SALES AND MARKETING

     We approach sales and marketing on three levels: engineer to engineer,
salesperson to procurement, and factory to factory. Our approach is to treat an
existing program as a marketing platform for the next program. Our engineering,
marketing, and sales groups provide ongoing services to our customers throughout
the life of product programs. These services include implementing continuous
improvement tools related to both the product's cost and technical performance.
This service function allows us to market future sales within our customer base.

     We market our services primarily in North America, Asia, and Europe through
a direct technical sales force resident in those areas. A staff of in-house,
Arizona-based engineering personnel directs and aids all sales personnel. We
have 15 sales persons worldwide.

     Our sales to customers in Europe represented approximately 46.7% of net
sales in 1999, approximately 33.6% of net sales in 2000. Our sales to customers
in Asia represented approximately 35.3% of net sales in 1999, approximately
50.6% of net sales in 2000. Since there was not a substantive change in our
customer base from 1999 to 2000, the increase in Asian sales is primarily the
result of our existing customers moving production of their products into Asian
countries.

     We have a representative relationship with Mitsui Co., Ltd. of Tokyo,
Japan. Under this relationship, Mitsui markets and sells LCD and microdisplay
products in Japan. We recently expanded that relationship to include the
geographic territories of Taiwan, Korea and South America with respect to our
LCD products.

CUSTOMERS

     Our strategy involves concentrating our efforts on providing design and
production services to leading companies in mobile handsets and other wireless
communication, data collection, office automation, medical equipment, and other
commercial and consumer marketplaces. As a result, we derive our net sales from
services provided to a limited number of customers.

     Our largest customer is Motorola. Sales to Motorola accounted for
approximately 86.9% of our net sales in 2000 and 86.1% of our net sales in 1999.
No customer other than Motorola accounted for more than 10.0% of our net sales
in 1999 or 2000. Sales to Motorola currently are made through multiple national
and international buyers, and products are delivered to diverse geographical
regions throughout the world, including Asia, North America, and Europe.
Substantially all of our net sales to Motorola have been for mobile handset
applications, and we are currently in the design or manufacturing phase on most
of their key platform programs. Motorola has an LCD module allocation process in
which it designates key LCD module vendors, including us, and communicates to
each vendor the anticipated annual range of purchases. Although the allocation
process does not provide a guarantee of business to us, it provides an
indication of Motorola's business expectations for 2001. See Item 1 "Business --
Special Considerations -- Motorola accounts for a significant portion of our
sales."

BACKLOG

     As of December 31, 2000, we had a backlog of orders of approximately $63.8
million. The backlog of orders as of December 31, 1999 was approximately $46.3
million. Our backlog consists of product orders for which confirmed purchase
orders have been received and which are scheduled for shipment within 12 months.
Most orders are subject to rescheduling or cancellation by the customer with
limited penalties. Because of the possibility of customer changes in delivery
schedules or cancellations and potential delays in product shipments, our
backlog as of a particular date may not be indicative of net sales for any
succeeding period.


                                       8
<PAGE>   11
MANUFACTURING SERVICES, FACILITIES, AND QUALITY CONTROL

Manufacturing Services

     We have organized our manufacturing geographically to optimize the
combination of technology and labor factors. This organization enables us to
compete solely on the basis of cost, if necessary, with suppliers of similar
products and services throughout the world. Our advanced manufacturing
techniques include surface mount technologies, chip-on-board, chip-on-flex,
chip-on-glass, flip-chip, tape automated bonding, and sophisticated testing
systems throughout these processes.

     We seek to increase our value to our customers by providing responsive,
flexible, total manufacturing services. To date, our manufacturing services have
been concentrated on the manufacture of LCDs and assembly of display modules
that we have designed. We provide extended manufacturing services beyond these
core services, however, if the customer requires them. Extended services may
include adding additional components, such as keypads, microphones, speakers,
light guides, and optics, or the turnkey manufacture of a complete assembly.

Manufacturing Facilities

     We currently conduct manufacturing operations in Arizona; Manila, the
Philippines; and Beijing, China. The Arizona facility houses a Class 1000 "clean
room" and LCD fabrication and prototyping operations. We utilize this facility
primarily to conduct LCD research and development, to produce prototype and pre-
production runs of devices for customer approval, to conduct full production
runs of low-volume devices, and to develop advanced manufacturing processes that
can be applied in Manila and Beijing during full-scale production. In addition,
the facility has the largest fully automated LCD production capacity in North
America. This highly automated line enables us to eliminate substantially our
dependence on foreign suppliers of LCDs. Facility personnel include a team of
experts ranging from LCD research scientists to specialized engineers with
backgrounds in electronics, mechanics, chemistry, physics, and manufacturing. We
maintain a wide variety of state-of-the-art testing and quality control
equipment at the facility.

     We have also recently completed a dedicated LCoS microdisplay production
line at our Arizona facility. As a result of capacity and line-balancing issues,
we decided to operate the LCoS microdisplay fabrication line separately from the
LCD line. We are also completing construction of new clean rooms so that we can
perform all manufacturing, packaging, and module assembly for LCoS products at
our Arizona facility.

     We conduct high-volume LCD module manufacturing in Manila and Beijing. In
Manila, we have operated pursuant to a sub-assembly agreement with Technology
Electronic Assembly and Management Pacific Corporation, or TEAM, under which
TEAM supplies direct manufacturing services at a facility that TEAM owns and
that is located on land TEAM leases from the Philippine government. TEAM
manufactures, assembles, and tests devices that we design pursuant to procedures
set forth in the sub-assembly agreement in accordance with our specifications.
Under the sub-assembly agreement, TEAM supplies only the direct labor and
certain incidental services required to manufacture our products. We own the
manufacturing, assembling, and testing equipment, including automated die attach
and wire bond equipment with automatic pattern recognition features for die and
wire placement for LED die, as well as the processes and documentation that TEAM
uses at the Manila facility. We pay TEAM for the direct manufacturing personnel
based upon a negotiated available hourly rate. We employ all professional
personnel, including an operations manager, with a support staff consisting of
manufacturing supervisors; manufacturing, quality, and process engineers; and
logistics and administrative personnel at the TEAM facility.

     In July 2000, we exercised our right to terminate our old subcontract
agreement with TEAM effective January 1, 2001 and are continuing operations at
that facility under a temporary arrangement. We are negotiating to have in place
a new sub-assembly agreement with TEAM for that facility by the end of the first
quarter of 2001. The sub-assembly agreement requires us to maintain minimum
production levels. The termination of the new sub-assembly agreement or the
inability of TEAM to fulfill its requirements under the new sub-assembly
agreement would require us to acquire additional manufacturing facilities or to
contract for additional manufacturing services. See Item 1 "Business -- Special
Considerations -- We depend on our manufacturing operations in the Philippines."


                                       9
<PAGE>   12
     In May 2000, we signed a lease for a custom-designed, built-to-suit
manufacturing facility in the Carmelray Industrial Park near Manila in the
Philippines. The term of the lease for this second factory in Manila is 125
months starting upon the completion of the factory, expected to be by the end of
the first quarter of 2001. This new 65,000 square foot manufacturing and design
facility incorporates state-of-the-art manufacturing equipment and a class
10,000 cleanroom environment. This new facility will be staffed entirely with
direct labor employed by us, unlike the arrangement at the TEAM facility, in
which TEAM supplies the labor force. In addition, the new manufacturing facility
has been outfitted with specific tooling and equipment unique to our
manufacturing needs. The new facility is located in a special Philippines
economic zone (PEZA), which will allow us to take advantage of certain tax
benefits.

     Our Beijing facility is a high-volume display module manufacturing facility
similar to our facilities in Manila. We own the manufacturing facility in
Beijing, which we completed in 1999, and all of the equipment in that facility.
In addition, we employ all of the direct and indirect manufacturing employees at
the facility, including technicians, supervisors, and engineers.

Quality Control

     We recognize the need to maintain a strong reputation for quality as a
means of retaining existing customers and securing additional orders from them
as well as attracting new customers. We have an extensive quality control
program and maintain at each of our facilities quality systems and processes
that meet or exceed the demanding standards set by many leading OEMs in targeted
industries. We base our quality control program upon statistical process
control, which advocates continual quantitative measurements of crucial
parameters and uses those measurements in a closed-loop feedback system to
control the manufacturing process. We perform product life testing to help
ensure long-term product reliability. We analyze results of product life tests
and take actions to refine the manufacturing process or enhance the product
design.

     Increased global competition has led to increased customer expectations
with respect to price, delivery, and quality. Customers often evaluate price in
the quotation process and evaluate delivery and quality only after receiving the
product. Therefore, many customers preview a company's quality by viewing the
quality systems employed. We have received ISO 9002 and QS 9000 certification of
our Manila manufacturing facility and ISO 9001 certification of our
manufacturing facility and corporate headquarters in Tempe, Arizona. ISO and QS
are quality standards established by international organizations that attempt to
ensure that the processes used in development and production remain consistent.
This is accomplished through documentation maintenance, training, and management
review of the processes used. Although achieving an ISO or QS certification does
not assure that we will obtain future business, it is a factor that enables our
customers to recognize that our production processes meet these established,
global standards of performance.

COMPONENTS AND RAW MATERIALS

     Components and raw materials constitute a substantial portion of our
product costs. The principal components and raw materials we use in producing
our displays consist of LCD glass, application specific integrated circuits, or
ASICs, circuit boards, molded plastic parts, lead frames, and packaging
materials. Our procurement strategy is to secure alternative sources of supplies
for the majority of these materials. Many of these, however, must be obtained
from foreign suppliers, which subjects us to the risks inherent in obtaining
materials from foreign sources, including supply interruptions and currency
fluctuations. With one exception, our suppliers generally are meeting our
requirements, and we believe our strategic supplier alliances have further
strengthened our relations with offshore suppliers. We experienced material
shortages of ASICs in 1999 and 2000 as a result of the increased worldwide
demand for cellular handsets and as a result of supplier issues. These shortages
prevented us from meeting customer demand for certain of our products. Similar
shortages in the future could have a material adverse effect on our business.

RESEARCH, DEVELOPMENT, AND ENGINEERING

     We conduct an active and ongoing research, development, and engineering
program that focuses on advancing technology, developing improved design and
manufacturing processes, and improving the overall quality of the products and
services that we provide. Our goal is to provide our customers with new
solutions that address their needs. Research and development personnel
concentrate on LCD technology, especially on improving the


                                       10
<PAGE>   13
performance of current products and expanding the technology to serve new
markets. We also conduct research and development in manufacturing processes,
including those associated with efficient, high-volume production and electronic
packaging.

     With the availability of our high-volume LCD manufacturing line in Arizona,
we are focusing our research and development efforts on new display
technologies. We expect that these advanced display technologies will enable us
to provide our customers with differentiating products or products that provide
higher information content. These new technologies include active addressing,
sunlight readable LCDs, color LCDs, plastic LCDs, bi-stable LCDs, graphics and
color graphics, organic and polymer light emitting displays, and pixel-related
display technologies. These products may be available for use in custom devices
or in standard devices. We have undertaken a significant research and
development program and made substantial investments with respect to the
development of our LCoS microdisplays for potential use in projectors, monitors,
digital and high-definition televisions, and portable applications. The majority
of our available research and development personnel hours was dedicated to LCoS
microdisplays in 2000 and we expect that to continue in 2001.

     In October 1999, we signed a letter agreement with Tecdis S.p.A., a
European-based LCD company, to form an ASIC design center in Chatillon, Italy.
The ASIC design center will be known as Dora and will focus on the design of
ASICs necessary to drive the LCDs we and Tecdis design for our respective
customers. Recently, STMicroelectronics announced its participation in Dora and
its agreement to manufacture the ASICs designed by Dora.

INTELLECTUAL PROPERTY

     We rely on a variety of intellectual property methods, including patents,
trade secrets, trademarks, confidentiality agreements, licensing agreements, and
other forms of contractual provisions, to protect and advance our intellectual
property. Although our existing LCD display business has not historically
depended on intellectual property protection, we are manufacturing more advanced
display products for which we are actively seeking intellectual property
protection. For example, our LCiD technology is patented. We have also applied
for numerous other process, product, and design patents, all related to display
technologies. There can be no assurance that any of these patents will be issued
to us.

     We have also taken several steps to both protect and advance our LCoS
microdisplay technology.

     -    We have filed numerous patents relating to our LCoS microdisplay
          technology. These patents cover the areas of product design and
          manufacturing process technology. We have a strong emphasis in this
          area and expect to continue to file additional disclosures.

     -    In July 1999, we purchased the assets, including all production and
          test equipment, specialized laboratory equipment, and supporting
          design documentation and software, of the former Light Valve business
          unit of National Semiconductor. We also hired several key scientists
          of that business unit and acquired an exclusive, paid-up, royalty free
          license on all of the patents and intellectual property related to
          that business unit. This license covers all intellectual property
          relating to the processing, packaging, and testing of light valves and
          the integrated circuits necessary to manufacture and sell both light
          valves and light engines.

     -    In August 1999, we licensed the microdisplay technology of S-Vision
          Corporation, a former microdisplay competitor that had recently ceased
          operations. Under this agreement, we acquired an irrevocable, royalty
          free, fully paid-up, worldwide license to the intellectual property
          associated with S-Vision's digital backplane and optical systems,
          which provides us rights to manufacture certain microdisplay products
          and patented optical engines. In addition, S-Vision assigned to us a
          patent relating to the design and manufacture of microdisplay
          products.


                                       11
<PAGE>   14
COMPETITION

     We believe that Hosiden, Hyundai, Optrex, PCI, Philips, Samsung,
Seiko-Epson, Seiko Instruments, and Sharp constitute the principal competitors
for our passive LCD devices. Most of these competitors are large companies that
have greater financial, technical, marketing, manufacturing, vertical
integration, and personnel resources than we do. Our sales, profitability, and
success depend substantially upon our ability to compete with other providers of
display modules. We cannot provide assurance that we will continue to be able to
compete successfully with these organizations.

     We currently compete principally on the basis of the technical innovation,
engineering service, and performance of our display modules, including their
ease of use and reliability, as well as on their cost, timely design, and
manufacturing and delivery schedules. Our competitive position could be
adversely affected if one or more of our customers, particularly Motorola,
determines to design and manufacture their display modules internally or secures
them from other parties.

     Other large companies are currently pursuing microdisplay solutions. Texas
Instruments has developed a product, referred to as a DMD microdisplay, that
competes with our LCoS technology, and JVC is producing a similar liquid crystal
on silicon display based on its own technology. Numerous other established and
start-up companies are also pursuing similar and related technologies that may
compete with our LCoS technology.

ENVIRONMENTAL REGULATIONS

     Our operations create a small amount of hazardous waste, including various
epoxies, gases, inks, solvents, and other wastes. The amount of hazardous waste
we produce may increase in the future depending on changes in our operations.
The general issue of the disposal of hazardous waste has received increasing
focus from federal, state, local, and international governments and agencies and
has been subject to increasing regulation.

EMPLOYEES

     As of December 31, 2000, we employed a total of 2,074 persons, of whom 953
were employed through third-party contracts. Of our direct employees, 243 were
employees at our principal U.S. facility in Arizona and U.S. sales offices; 259
were employees at our manufacturing facility in Manila; 609 were employees at
our manufacturing facility in Beijing; and 10 were employees at our Three-Five
Systems Limited subsidiary in Swindon, England. We consider our relationship
with our employees to be good, and none of our employees currently are
represented by a union in collective bargaining with us.

     In 2000, TEAM provided the personnel engaged in the direct assembly of our
devices in Manila under the sub-assembly agreement between us and TEAM. As of
December 31, 2000, 953 persons performed direct labor operations at the Manila
facility through the sub-assembly agreement with TEAM.

EXECUTIVE OFFICERS

         The following table sets forth certain information regarding our
executive officers:

    NAME               AGE             POSITION HELD

Jack L. Saltich        57     President, Chief Executive Officer, and Director

Jeffrey D. Buchanan    45     Executive Vice President, Chief Financial Officer,
                              Secretary, Treasurer, and Director

Carl E. Derrington     50     Vice President, Chief Manufacturing Officer

Robert L. Melcher      61     Chief Technology Officer

Robert T. Berube       62     Principal Accounting Officer and Corporate
                              Controller


                                       12
<PAGE>   15
     Jack L. Saltich has served as a director and the President and Chief
Executive Officer of our company since July 1999. Mr. Saltich served as Vice
President of Advanced Micro Devices from May 1993 until July 1999; as Executive
Vice President of Applied Micro Circuits Corp. from January 1991 until March
1993; and as Vice President of VLSI from July 1988 until January 1991. Mr.
Saltich held a variety of executive positions for Motorola from July 1971 until
June 1988. These positions included serving as an Engineering Manager from May
1974 until January 1980, an Operation Manager from January 1980 until May 1982,
a Vice President and Director of the Bipolar Technology Center from May 1982
until June 1986, and a Vice President and Director of the Advanced Product
Research and Development Laboratory from June 1986 until June 1988.

     Jeffrey D. Buchanan has served as a director and Executive Vice President
of our company since June 1998; as Chief Financial Officer and Treasurer since
June 1996; and as Secretary since May 1996. Mr. Buchanan served as our Vice
President - Finance, Administration, and Legal from June 1996 until July 1998
and as our Vice President - Legal and Administration from May 1996 to June 1996.
Mr. Buchanan served from June 1986 until May 1996 as a business lawyer with
O'Connor, Cavanagh, Anderson, Killingsworth & Beshears. Mr. Buchanan was
associated with the international law firm of Davis Wright Tremaine from 1984 to
1986, and he was a senior staff person at Deloitte & Touche from 1982 to 1984.

     Carl E. Derrington has been our Chief Manufacturing Officer since May 1999.
Dr. Derrington joined our company in 1986 as a Director of Research and
Development. Since that time, Dr. Derrington has served as a Plant Manager from
January 1986 until September 1987, a Director of Engineering from September 1987
until August 1989, a Director of Manufacturing from August 1989 until April
1996, and a Director of Manufacturing Engineering from April 1996 until April
1999.

     Robert L. Melcher has been our Chief Technology Officer since October 1999.
Prior to joining our company, Dr. Melcher was employed at IBM in a variety of
management positions since 1970. He served as the Program Leader for Projection
Displays from 1993 to 1999 and immediately prior to that he was Director of the
Physical Sciences Department from 1990 to 1993.

     Robert T. Berube has been our Principal Accounting Officer since July 1998
and has served as our Corporate Controller since July 1990. Mr. Berube served as
Chief Financial Officer of Electronic Research Associate, Inc., a manufacturing
company, from July 1977 until April 1990.


                                       13
<PAGE>   16
                             SPECIAL CONSIDERATIONS

     You should carefully consider the following factors, in addition to those
discussed elsewhere in this Report, in evaluating our company and our business.

MOTOROLA ACCOUNTS FOR A SIGNIFICANT PORTION OF OUR SALES.

     Our business depends to a significant extent on Motorola's success in the
mobile handset business, particularly in the various major mobile handset
programs in which we participate. Any material delay, cancellation, or reduction
of orders from Motorola could have a material adverse effect on our business.

     Motorola has been our largest customer during each of the last five years.
Sales to Motorola accounted for approximately 86.9% of our net sales in 2000,
86.1% in 1999, 63.6% in 1998, 34.6% in 1997, 65.1% in 1996, and 80.5% in 1995.
Substantially all of our sales to Motorola were for mobile handset applications.

     Sales to Motorola currently are made under multiple product programs
administered by eight buyers operating in eight separate plants. During 2000,
the five largest of these product programs accounted for a total of 75.9% of our
net sales, with the largest program accounting for 32.8% of our net sales.
During 1999, the five largest of these product programs accounted for a total of
79.1% of our net sales, with the largest program accounting for 33.0% of our net
sales.

     A decline in sales to Motorola could occur at any time. For example, an
unexpected reduction in Motorola mobile handset programs reduced our net sales
to Motorola from $73.7 million in 1995 to $39.5 million in 1996 and $29.2
million in 1997. Since Motorola has no long-term contractual commitments to
purchase any of our products, we could experience similar declines in our net
sales in the future.

WE ARE SUBJECT TO LENGTHY DEVELOPMENT PERIODS AND PRODUCT ACCEPTANCE CYCLES.

     We sell our display modules to OEMs, which then incorporate them into the
products they sell. OEMs make the determination during their product development
programs whether to incorporate our display modules or pursue other
alternatives. This requires us to make significant investments of time and
capital in the custom design of display modules well before our customers
introduce their products incorporating these displays and before we can be sure
that we will generate any significant sales to our customers or even recover our
investment. During a customer's entire product development process, we face the
risk that our display will fail to meet our customer's technical, performance,
or cost requirements or will be replaced by a competing product or alternative
technological solution. Even if we complete our design process in a manner
satisfactory to our customer, the customer may delay or terminate its product
development efforts. The occurrence of any of these events would adversely
affect our operating results.

WE DO NOT HAVE LONG-TERM PURCHASE COMMITMENTS FROM OUR CUSTOMERS.

     Our customers, including Motorola, generally do not provide us with firm,
long-term volume purchase commitments. Although we have begun to enter into more
manufacturing contracts with our customers, these contracts clarify order lead
times, inventory risk allocation, and similar matters rather than provide firm,
long-term volume purchase commitments. As a result, customers can cancel
purchase commitments or reduce or delay orders at any time. The cancellation,
delay, or reduction of customer commitments could result in our holding excess
and obsolete inventory or having unabsorbed manufacturing overhead. The large
percentage of our sales to customers in the electronics industry, which is
subject to severe competitive pressures, rapid technological change, and product
obsolescence, increases our inventory and overhead risks.

     Our operating results have been materially and adversely affected in the
past as a result of the failure to obtain anticipated orders and deferrals or
cancellations of purchase commitments because of changes in customer
requirements. For example, we have made announcements in the past that sales
would not meet our expectations because of delays in customer programs.


                                       14
<PAGE>   17
WE DEPEND ON THE MARKET ACCEPTANCE OF THE PRODUCTS OF OUR CUSTOMERS.

     We do not sell any products to end users. Instead, we design and
manufacture various product solutions that our customers incorporate into their
products. As a result, our success depends almost entirely upon the widespread
market acceptance of our customers' products. Any significant slowdown in the
demand for our customers' products would adversely affect our business.

     Because our success depends on the widespread market acceptance of our
customers' products, we must identify industries that have significant growth
potential and establish relationships with OEMs in those industries. Our failure
to identify potential growth opportunities or establish relationships with OEMs
in those industries would adversely affect our business.

     Our dependence on the success of the products of our customers exposes us
to a variety of risks, including the following:

     -    our ability to provide significant design and manufacturing services
          for customers on a timely and cost-effective basis;

     -    our success in maintaining customer satisfaction with our design and
          manufacturing services;

     -    our ability to match our design and manufacturing capacity with
          customer demand and to maintain satisfactory delivery schedules;

     -    customer order patterns, changes in order mix, and the level and
          timing of orders placed by customers that we can complete in a
          quarter; and

     -    the cyclical nature of the industries and markets we serve.

Our failure to address these risks may cause our sales to decline.

OUR EMERGING MICRODISPLAY BUSINESS MAY NOT BE SUCCESSFUL.

     A key element of our current business plan involves the commercialization
of our microdisplay technology. The success of this effort depends on numerous
factors. As a result, we could be unable to expand our business as we currently
anticipate and may make substantial investments in product development,
manufacturing, and marketing efforts that may not result in microdisplay sales.

     Manufacturing an LCoS microdisplay involves a significantly different
procedure than manufacturing a typical liquid crystal display. Although we added
additional equipment to our Arizona manufacturing facility in the last two years
for manufacturing LCoS microdisplays, the manufacture of microdisplays will
require us to overcome numerous challenges, including the following:

     -    the use of new materials, including silicon;

     -    the modification of equipment and processes to accommodate the
          miniature size of the product;

     -    the implementation of new manufacturing techniques;

     -    the incorporation of new handling procedures;

     -    the maintenance of cleaner manufacturing environments; and

     -    the ability to master tighter tolerances in the manufacturing process.

     We could experience significant problems in commencing volume production of
LCoS microdisplays. These problems could result in the delay of the full
implementation of high-volume LCoS microdisplay production. In addition, lower
than expected manufacturing yields could significantly and adversely affect us
because of the relatively high cost of the silicon backplanes used in LCoS
microdisplays.

     Various target markets for our microdisplays, including projectors,
monitors, digital and high-definition televisions, and portable microdisplays,
are uncertain, may be slow to develop, or could utilize competing technologies.
Many manufacturers have well-established positions in the projector and monitor
markets. As a


                                       15
<PAGE>   18
result, we must provide these manufacturers with lower cost, comparable
performance microdisplays for their products. Digital and high-definition
television has only recently become available to consumers, and widespread
market acceptance is uncertain. Penetrating this market will require us to offer
lower cost alternatives to existing technology. In addition, the commercial
success of the portable microdisplay market is uncertain. Gaining acceptance in
this market may prove difficult because of the radically different approach of
microdisplays to the presentation of information. The failure of any of these
target markets to develop as we expect, or our failure to penetrate these
markets, will impede our anticipated sales growth. Even if our technology
successfully meets our price and performance goals, our customers may not
achieve commercial success in selling their products that incorporate our
microdisplay technology.

WE FACE INTENSE COMPETITION.

     We serve intensely competitive industries that are characterized by price
erosion, rapid technological change, and competition from major domestic and
international companies. This intense competition could result in pricing
pressures, lower sales, reduced margins, and lower market share. Many of our
competitors have greater market recognition, larger customer bases, and
substantially greater financial, technical, marketing, distribution, and other
resources than we possess. As a result, they may be able to introduce new
products and respond to customer requirements more quickly than we can.

     Our competitive position could suffer if one or more of our customers
decide to design and manufacture their own display modules, to use standard
devices, to contract with our competitors, or to use alternative technologies.
In addition, our customers typically develop a second source, even for displays
we design for them. These second source suppliers may win an increasing share of
a program, particularly as it grows and matures, by competing primarily on price
rather than on design capability.

     Our ability to compete successfully depends on a number of factors, both
within and outside our control. These factors include the following:

     -    our success in designing and manufacturing new product solutions,
          including those implementing new technologies;

     -    our ability to address the needs of our customers;

     -    the quality, performance, reliability, features, ease of use, pricing,
          and diversity of our product solutions;

     -    foreign currency fluctuations, which may cause a foreign competitor's
          products to be priced significantly lower than our product solutions;

     -    the quality of our customer services;

     -    our efficiency of production;

     -    the rate at which customers incorporate our product solutions into
          their own products; and

     -    product or technology introductions by our competitors.

SHORTAGES OF COMPONENTS AND MATERIALS MAY DELAY OR REDUCE OUR SALES AND INCREASE
OUR COSTS.

     Our inability to obtain sufficient quantities of components and other
materials necessary to produce our displays could result in reduced or delayed
sales or lost orders. Any delay in or loss of sales could adversely impact our
operating results. We obtain many of the materials we use in the manufacture of
our displays from a limited number of foreign suppliers, particularly suppliers
located in Asia, and we do not have long-term supply contracts with any of them.
As a result, we are subject to economic instability and currency fluctuations in
these Asian countries as well as to increased costs, supply interruptions, and
difficulties in obtaining materials. Our customers also may encounter
difficulties or increased costs in obtaining from others the materials necessary
to produce their products into which our product solutions are incorporated.

     Materials and components for some of our major programs from time to time
have been subject to allocation because of shortages of these materials and
components. During 1998, we occasionally delayed sales of


                                       16
<PAGE>   19
our LCD modules as a result of the unavailability of LCD polarizers and IC
drivers, or ASICs. During 1999, we experienced difficulties obtaining our
requirements for ASICs as a result of a worldwide shortage. We also experienced
a material supply interruption in ASICs for a key program in the fourth quarter
of 2000. These shortages resulted in lost sales opportunities. Similar shortages
in the future could have a material adverse effect on our business.

WE MUST MAINTAIN SATISFACTORY MANUFACTURING YIELDS AND CAPACITY.

     Our inability to maintain high levels of productivity or satisfactory
delivery schedules at our manufacturing facilities in Manila, Beijing, or
Arizona would adversely affect our operating results. The design and manufacture
of LCDs and display modules are highly complex processes that are sensitive to a
wide variety of factors, including the level of contaminants in the
manufacturing environment, impurities in the materials used, and the performance
of personnel and equipment. As is typical in the industry, at times we have
experienced lower than anticipated manufacturing yields and lengthening of
delivery schedules. We may encounter lower manufacturing yields and longer
delivery schedules as we continue to ramp up our high-volume LCD line to greater
production levels and begin to manufacture LCoS microdisplays. In addition, the
complexity of manufacturing processes will increase along with increases in the
sophistication of display modules.

     We anticipate that we will expand our capacity by establishing one or more
additional production facilities. We will face all of the risks inherent in
constructing, equipping, and commencing operations in any new facilities that we
establish. These risks include the following:

     -    the ability to identify and acquire or lease suitable property;

     -    construction delays and cost overruns;

     -    the ability to procure and install necessary equipment;

     -    the ability to hire, train, and manage manufacturing personnel; and

     -    production delays, unfavorable manufacturing yields, and lengthening
          delivery schedules.

     These risks could be more pronounced with respect to any facilities that we
establish in foreign countries. Any problems with our LCD manufacturing
operations could result in the lengthening of our delivery schedules, reductions
in the quality or performance of our design and manufacturing services, and
reduced customer satisfaction.

OUR BUSINESS DEPENDS ON NEW PRODUCTS AND TECHNOLOGIES.

     We operate in rapidly changing industries. Technological advances, the
introduction of new products, and new design and manufacturing techniques could
adversely affect our business unless we are able to adapt to the changing
conditions. As a result, we will be required to expend substantial funds for and
commit significant resources to:

     -    continue research and development activities on existing and potential
          product solutions;

     -    engage additional engineering and other technical personnel;

     -    purchase advanced design, production, and test equipment; and

     -    expand our manufacturing capacity.

     Our future operating results will depend to a significant extent on our
ability to continue to provide new product solutions that compare favorably on
the basis of time to introduction, cost, and performance with the design and
manufacturing capabilities of OEMs and competitive third-party suppliers. Our
success in attracting new customers and developing new business depends on
various factors, including the following:

     -    utilization of advances in technology;

     -    innovative development of new solutions for customer products;


                                       17
<PAGE>   20
     -    efficient and cost-effective services; and

     -    timely completion of the design and manufacture of new product
          solutions.

OUR EFFORTS TO DEVELOP NEW TECHNOLOGIES MAY NOT RESULT IN COMMERCIAL SUCCESS.

     Our research and development efforts with respect to new technologies may
not result in customer or widespread market acceptance. Some or all of those
technologies may not successfully make the transition from the research and
development lab to cost-effective production as a result of technology problems,
competitive cost issues, yield problems, and other factors. Even when we
successfully complete a research and development effort with respect to a
particular technology, our customers may determine not to introduce or may
terminate products utilizing the technology for a variety of reasons, including
the following:

     -    difficulties with other suppliers of components for the products;

     -    superior technologies developed by our competitors;

     -    price considerations;

     -    lack of anticipated or actual market demand for the products; and

     -    unfavorable comparisons with products introduced by others.

     For example, in 1999 we deferred the commercialization of our Liquid
Crystal active Drive, or LCaD(R), display product line. We have decided to
concentrate our resources elsewhere and have not yet determined whether or to
what extent we will pursue commercialization of the LCaD product line.

     The nature of our business requires us to make capital expenditures and
investments for new technologies. For example, our capital expenditures,
including tooling and licenses, for LCoS microdisplays, currently our largest
research and development effort, have been over $9.6 million through December
31, 2000. To facilitate the development of our LCoS microdisplay products, we
also made an equity investment of $3.8 million in Inviso, Inc., formerly
Siliscape, Inc., during 1998 and 2000 and purchased assets and technology of the
former Light Valve business unit of National Semiconductor Corporation for
approximately $3.6 million during 1999. We may be required to make similar
investments and acquisitions in the future to maintain or enhance our ability to
offer technological solutions.

     Significant expenditures relating to one or more new technologies,
especially LCoS microdisplays, that ultimately prove to be unsuccessful for any
reason could have a material adverse effect on us. In addition, any investments
or acquisitions, such as Inviso and the assets and technology of the former
Light Valve business unit, made to enhance our technologies may prove to be
unsuccessful.

WE FACE RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.

     Our manufacturing operations in Manila, Beijing, and Arizona and our sales
and distribution operations in Europe and Asia create a number of logistical and
communications challenges. Our international operations also expose us to
various economic, political, and other risks, including the following:

     -    management of a multi-national organization;

     -    compliance with local laws and regulatory requirements as well as
          changes in those laws and requirements;

     -    employment and severance issues;

     -    overlap of tax issues;

     -    tariffs and duties;

     -    possible employee turnover or labor unrest;

     -    lack of developed infrastructure;

     -    the burdens and costs of compliance with a variety of foreign laws;
          and


                                       18
<PAGE>   21
     -    political or economic instability in certain parts of the world.

     Changes in policies by the United States or foreign governments resulting
in, among other things, increased duties, higher taxation, currency conversion
limitations, restrictions on the transfer or repatriation of funds, limitations
on imports or exports, or the expropriation of private enterprises also could
have a material adverse effect on us. Any actions by our host countries to
reverse policies that encourage foreign investment or foreign trade also could
adversely affect our operating results. In addition, U.S. trade policies, such
as "most favored nation" status and trade preferences for certain Asian nations,
could affect the attractiveness of our services to our U.S. customers.

WE DEPEND ON OUR OPERATIONS IN ARIZONA.

     Our Arizona facility and its high-volume LCD manufacturing line are
critical to our success. We utilize this high-volume line to produce a majority
of our own requirements for LCDs. We also have installed a dedicated high-volume
microdisplay manufacturing line in this facility. We intend, at least initially,
to produce all of our LCoS microdisplays on this dedicated line. This facility
also houses our principal research, development, engineering, design, and
managerial operations. Any event that causes a disruption of the operation of
this facility for even a relatively short period of time would adversely affect
our ability to provide both technical and manufacturing support for our
customers.

WE DEPEND ON OUR MANUFACTURING OPERATIONS IN THE PHILIPPINES.

     Any disruption or termination of our manufacturing operations in Manila or
air transportation with the Philippines, even for a relatively short period of
time, would adversely affect our operations. The Philippines have been subject
to volcanic eruptions, typhoons, and substantial civil disturbances, including
attempted military coups against the government, since we commenced operations
at the facility in 1986. Capital investments in the Philippines amounted to
approximately $17.5 million through December 31, 2000. We believe that our
manufacturing operations in Manila constitute one of our most important
resources and that it would be difficult to replace the low-cost,
high-performance facility or the highly trained production staff in the event of
the disruption or termination of our manufacturing operations in Manila.

     Our operations in Manila also depend on the business and financial
condition of the third-party subcontractor that owns the manufacturing facility,
which is located on land the subcontractor leases from the Philippine
government. The subcontractor operates the facility utilizing equipment,
processes, and documentation that we own and supervisory personnel that we
employ. The subcontractor provides us with direct production personnel. The
subcontractor also utilizes additional space in the facility to produce products
for other entities unrelated to us. The failure of the subcontractor to fulfill
its obligations to us would adversely affect our operating results. We are
currently renegotiating a new sub-assembly agreement with that sub-contractor
although we are continuing operations with the subcontractor. We terminated the
prior sub-assembly agreement effective January 1, 2001. If we are unable to
successfully negotiate a new sub-assembly agreement, we will not have that
facility available to us and all production will be required to be carried out
at the new facility that is expected to be operational by the end of the first
quarter of 2001.

WE DEPEND ON OUR MANUFACTURING OPERATIONS IN CHINA.

     We commenced manufacturing operations in Beijing, China, during 1998 in a
leased temporary facility. During 1999, we completed the construction of a
permanent, high-volume LCD module manufacturing facility in Beijing, which is
similar to our Manila facility. Capital investments in China amounted to
approximately $11.5 million through December 31, 2000. We are considering
expansion of our Beijing manufacturing facility.

     Our operations and assets are subject to significant political, economic,
legal, and other uncertainties in China. The Chinese government recently has
been pursuing economic reform policies, including the encouragement of foreign
trade and investment and greater economic decentralization. The Chinese
government, however, may not continue to pursue these policies, may not
successfully pursue these policies, or may significantly alter these policies
from time to time. China currently does not have a comprehensive and highly
developed system of laws, particularly with respect to foreign investment
activities and foreign trade. Enforcement of existing and future laws and
contracts is uncertain, and implementation and interpretation of laws may be
inconsistent. As the Chinese legal


                                       19
<PAGE>   22
system develops, the passage of new laws, changes in existing laws, and the
preemption of local regulations by national laws may adversely affect us. We
also could be adversely affected by a number of other factors, including the
following:

     -    the imposition of austerity measures intended to reduce inflation;

     -    inadequate development or maintenance of infrastructure, including the
          unavailability of adequate power and water supplies, transportation,
          raw materials, and parts; and

     -    a deterioration of the general political, economic, or social
          environment in China.

     In November 1999, the United States and China signed an agreement that will
lift trade barriers between the two countries and that advances China's efforts
to join the World Trade Organization. Special interest groups have raised
objections to these efforts, and we cannot be certain whether or to what extent
trade relations with China will continue to improve. Any developments that
adversely affect trade relations between the United States and China in the
future could adversely affect us by increasing the cost to U.S. customers of
products manufactured by us in China.

WE FACE RISKS ASSOCIATED WITH INTERNATIONAL TRADE AND CURRENCY EXCHANGE.

     Political and economic conditions abroad may adversely affect the foreign
manufacture and sale of our displays. Protectionist trade legislation in either
the United States or foreign countries, such as a change in the current tariff
structures, export or import compliance laws, or other trade policies, could
adversely affect our ability to manufacture or sell displays in foreign markets
and to purchase materials or equipment from foreign suppliers.

     While we transact business predominantly in U.S. dollars and bill and
collect most of our sales in U.S. dollars, we collect a portion of our revenue
in non-U.S. currencies, such as the Chinese renminbi. In the future, customers
increasingly may make payments in non-U.S. currencies, such as the Euro. In
addition, we account for a portion of our costs, such as payroll, rent, and
indirect operating costs, in non-U.S. currencies, including Philippine pesos,
British pounds sterling, and Chinese renminbi.

     Fluctuations in foreign currency exchange rates could affect our cost of
goods and operating margins and could result in exchange losses. In addition,
currency devaluation can result in a loss to us if we hold deposits of that
currency. The Philippine peso suffered a major devaluation in late 1997, and the
Chinese renminbi has experienced significant devaluation against most major
currencies over the last five years. Hedging foreign currencies can be
difficult, especially if the currency is not freely traded. We cannot predict
the impact of future exchange rate fluctuations on our operating results.

     The risks described above are particularly important since international
sales represented 85.2% of our net sales in 2000 and 82.0% of our net sales in
1999. Sales in foreign markets, primarily Europe and China, to OEMs based in the
United States accounted for almost all of our international sales in both of
these periods. In the future, we expect sales to OEMs based in Europe and China
to increase.

VARIABILITY OF CUSTOMER REQUIREMENTS MAY ADVERSELY AFFECT OUR OPERATING RESULTS.

     Custom manufacturers for OEMs must provide increasingly rapid product
turnaround and respond to ever-shorter lead times. A variety of conditions, both
specific to individual customers and generally affecting the demand for their
products, may cause customers to cancel, reduce, or delay orders. Cancellations,
reductions, or delays by a significant customer or by a group of customers could
adversely affect our business. On occasion, customers require rapid increases in
production, which can strain our resources and reduce our margins. Although we
have increased our manufacturing capacity, we may lack sufficient capacity at
any given time to meet our customers' demands if their demands exceed
anticipated levels.

OUR OPERATING RESULTS HAVE SIGNIFICANT FLUCTUATIONS.

     In addition to the variability resulting from the short-term nature of our
customers' commitments, other factors contribute to significant periodic and
seasonal quarterly fluctuations in our results of operations. These factors
include the following:


                                       20
<PAGE>   23
     -    the timing of orders;

     -    the volume of orders relative to our capacity;

     -    product introductions and market acceptance of new products or new
          generations of products;

     -    evolution in the life cycles of customers' products;

     -    timing of expenditures in anticipation of future orders;

     -    effectiveness in managing manufacturing processes;

     -    changes in cost and availability of labor and components;

     -    product mix;

     -    pricing and availability of competitive products and services; and

     -    changes or anticipated changes in economic conditions.

     Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future period,
our operating results may be below expectations of public market analysts or
investors. If this occurs, our stock price may drop.

WE MUST EFFECTIVELY MANAGE OUR GROWTH.

     The failure to manage our growth effectively could adversely affect our
operations. We have increased the number of our manufacturing and design
programs and plan to expand further the number and diversity of our programs in
the future. Our ability to manage our planned growth effectively will require us
to

     -    enhance our operational, financial, and management systems;

     -    expand our facilities and equipment; and

     -    successfully hire, train, and motivate additional employees, including
          the technical personnel necessary to operate our new production
          facility in Beijing.

     The expansion and diversification of our product and customer base may
result in increases in our overhead and selling expenses. We also may be
required to increase staffing and other expenses as well as our expenditures on
capital equipment and leasehold improvements in order to meet the anticipated
demand of our customers. For example, prior to the receipt of orders, we
substantially increased our manufacturing capacity in 1998 by starting up
manufacturing operations in Beijing. We plan further expansion of our
manufacturing capacity. Customers, however, generally do not commit to firm
production schedules for more than a short time in advance. Any increase in
expenditures in anticipation of future orders that do not materialize would
adversely affect our profitability. Customers also may require rapid increases
in design and production services that place an excessive short-term burden on
our resources.

WE DEPEND ON KEY PERSONNEL.

     Our development and operations depend substantially on the efforts and
abilities of our senior management and technical personnel. The competition for
qualified management and technical personnel is intense. The loss of services of
one or more of our key employees or the inability to add key personnel,
including those required for our LCD manufacturing facility, could have a
material adverse effect on us. Although we maintain non-competition and
nondisclosure covenants with certain key personnel, we do not have any
fixed-term agreements with, or key person life insurance covering, any officer
or employee.

WE MUST PROTECT OUR INTELLECTUAL PROPERTY, AND OTHERS COULD INFRINGE ON OR
MISAPPROPRIATE OUR RIGHTS.

     We believe that our continued success depends in part on protecting our
proprietary technology. Third parties could claim that we are infringing their
patents or other intellectual property rights. In the event that a third party
alleges that we are infringing its rights, we may not be able to obtain licenses
on commercially reasonable terms from the third party, if at all, or the third
party may commence litigation against us. The failure to obtain


                                       21
<PAGE>   24
necessary licenses or other rights or the institution of litigation arising out
of such claims could materially and adversely affect us.

     We rely on a combination of patent, trade secret, and trademark laws,
confidentiality procedures, and contractual provisions to protect our
intellectual property. We seek to protect certain of our technology under trade
secret laws, which afford only limited protection. We face risks associated with
our intellectual property, including the following:

     -    pending patent applications may not be issued;

     -    intellectual property laws may not protect our intellectual property
          rights;

     -    third parties may challenge, invalidate, or circumvent any patent
          issued to us;

     -    rights granted under patents issued to us may not provide competitive
          advantages to us;

     -    unauthorized parties may attempt to obtain and use information that we
          regard as proprietary despite our efforts to protect our proprietary
          rights;

     -    others may independently develop similar technology or design around
          any patents issued to us; and

     -    effective protection of intellectual property rights may be limited or
          unavailable in some foreign countries, such as China, in which we
          operate.

     We may not be able to obtain effective trademark, service mark, copyright,
and trade secret protection in every country in which we sell our products. We
may find it necessary to take legal action in the future to enforce or protect
our intellectual property rights or to defend against claims of infringement.
Litigation can be very expensive and can distract our management's time and
attention, which could adversely affect our business. In addition, we may not be
able to obtain a favorable outcome in any intellectual property litigation.

THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE.

     The market price of our common stock has been extremely volatile. Our stock
price increased dramatically during the three-year period ended December 31,
1994, but declined significantly during 1995 and 1996. The stock price increased
again during 1997, but declined significantly in 1998. Our stock price again
increased significantly during 1999 and in early 2000, but suffered a major
decline in the second half of 2000. The trading price of our common stock in the
future could continue to be subject to wide fluctuations in response to various
factors, including the following:

     -    variations in our quarterly operating results;

     -    actual or anticipated announcements of technical innovations or new
          product developments by us or our competitors;

     -    changes in analysts' estimates of our financial performance;

     -    general conditions in the electronics industry; and

     -    worldwide economic and financial conditions.

     In addition, the stock market has experienced extreme price and volume
fluctuations that have particularly affected the market prices for many
high-technology companies and that often have been unrelated to the operating
performance of these companies. These broad market fluctuations and other
factors may adversely affect the market price of our common stock.

THE ELECTRONICS INDUSTRY IS CYCLICAL.

     The electronics industry has experienced significant economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production over-capacity. In addition, the
electronics industry is cyclical in nature. We have sought to reduce our
exposure to industry downturns and cyclicality by providing design and
production services for leading companies in rapidly expanding segments of


                                       22
<PAGE>   25
the electronics industry. We may, however, experience substantial
period-to-period fluctuations in future operating results because of general
industry conditions or events occurring in the general economy.

WE MUST FINANCE THE GROWTH OF OUR BUSINESS AND THE DEVELOPMENT OF NEW PRODUCTS.

     To remain competitive, we must continue to make significant investments in
research and development, equipment, and facilities. As a result of the increase
in fixed costs and operating expenses related to these capital expenditures, our
failure to increase sufficiently our net sales to offset these increased costs
would adversely affect our operating results.

     From time to time, we may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand our design
and production facilities and equipment. We cannot predict the timing or amount
of any such capital requirements at this time. If such financing is not
available on satisfactory terms, we may be unable to expand our business or to
develop new business at the rate desired and our operating results may suffer.
Debt financing increases expenses and must be repaid regardless of operating
results. Equity financing could result in additional dilution to existing
stockholders.

POTENTIAL STRATEGIC ALLIANCES MAY NOT ACHIEVE THEIR OBJECTIVES.

     We anticipate that we will enter into various strategic alliances. Among
other matters, we will explore strategic alliances designed to enhance or
complement our technology or to work in conjunction with our technology; to
increase our manufacturing capacity; to provide necessary know-how, components,
or supplies; and to develop, introduce, and distribute products utilizing our
technology. Any strategic alliances may not achieve their strategic objectives,
and parties to our strategic alliances may not perform as contemplated.

ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE STOCKHOLDER VALUE, AND HARM OUR OPERATING RESULTS.

     We expect to review opportunities to buy other businesses or technologies
that would complement our current products, expand the breadth of our markets,
enhance our technical capabilities, or otherwise offer growth opportunities.
While we have no current agreements or negotiations underway, we may buy
businesses, products, or technologies in the future. If we make any future
acquisitions, we could issue stock that would dilute existing stockholders'
percentage ownership, incur substantial debt, or assume contingent liabilities.
Our experience in acquiring other businesses and technologies is limited.
Potential acquisitions also involve numerous risks, including the following:

     -    problems assimilating the purchased operations, technologies, or
          products;

     -    unanticipated costs associated with the acquisition;

     -    diversion of management's attention from our core businesses;

     -    adverse effects on existing business relationships with suppliers and
          customers;

     -    risks associated with entering markets in which we have no or limited
          prior experience; and

     -    potential loss of key employees of purchased organizations.

     We cannot assure you that we would be successful in overcoming problems
encountered in connection with such acquisitions, and our inability to do so
could adversely affect our business.

WE ARE SUBJECT TO ENVIRONMENTAL REGULATIONS.

     Our operations result in the creation of small amounts of hazardous waste,
including various epoxies, gases, inks, solvents, and other wastes. Any failure
by us to control the use, or adequately restrict the discharge, of hazardous
substances could subject us to future liabilities. We are subject to federal,
state, and local governmental regulations related to the use, storage,
discharge, and disposal of toxic, volatile, or otherwise hazardous chemicals
used in our design and manufacturing processes. The amount of hazardous waste
produced by us may increase in the future depending on changes in our
operations. Our failure to comply with present or future environmental
regulations could result in the imposition of fines, suspension of production,
or a cessation of operations.


                                       23
<PAGE>   26
Compliance with these regulations could require us to acquire costly equipment
or to incur other significant expenses.

CHANGE IN CONTROL PROVISIONS MAY ADVERSELY AFFECT EXISTING STOCKHOLDERS.

     Our restated certificate of incorporation and the Delaware General
Corporation Law contain provisions that may have the effect of making more
difficult or delaying attempts by others to obtain control of our company, even
when these attempts may be in the best interests of stockholders. Our restated
certificate also authorizes the board of directors, without stockholder
approval, to issue one or more series of preferred stock, which could have
voting and conversion rights that adversely affect or dilute the voting power of
the holders of common stock. Delaware law also imposes conditions on certain
business combination transactions with "interested stockholders."

WE DO NOT PAY CASH DIVIDENDS.

     We have never paid any cash dividends on our common stock and do not
anticipate that we will pay cash dividends in the foreseeable future. Instead,
we intend to apply earnings to the expansion and development of our business.

ITEM 2.            PROPERTIES

     We own and occupy a 97,000 square foot facility in Tempe, Arizona, which
houses our U.S.-based manufacturing operations; our research, development,
engineering, design, and corporate functions; and the largest fully automated
LCD glass manufacturing operations in North America. We entered into a ground
lease for this facility that extends through March 31, 2069, subject to renewal
and purchase options as well as early termination provisions. Costs to
construct, furnish, and equip the Tempe facility were approximately $24.0
million.

     We lease approximately 3,500 square feet of office and warehouse space in
Swindon, United Kingdom, where we maintain our European administrative offices
and a distribution warehouse.

     We lease an approximately 65,000 square foot manufacturing facility in
Carmelray Industrial Park, Barangay Tulo, Calamba, Laguna, the Philippines with
an option to purchase the premises. The lease expires in 2010.

     We occupy approximately 60,000 square feet of manufacturing space in
Manila, the Philippines, at the TEAM facility. We terminated our sub-assembly
agreement with TEAM effective January 1, 2001, although we are continuing
operations at that facility. We are currently renegotiating a sub-assembly
agreement with TEAM and plan to have that agreement in place by the end of the
first quarter 2001.

     We own and occupy a 46,000 square foot facility in Beijing, China,
including 29,000 square feet of manufacturing space. We constructed this
facility on property that we have purchased on a long-term land use contract.
Costs to construct, furnish, and equip the Beijing facility were approximately
$10.9 million.

ITEM 3 .           LEGAL PROCEEDINGS

     There are no legal proceedings to which we are a party or to which any of
our properties are subject, other than routine litigation incident to our
business that is covered by insurance or an indemnity or that we do not expect
to have a material adverse effect on our company. It is possible, however, that
we could incur claims for which we are not insured or that exceed the amount of
our insurance coverage.

ITEM 4.            SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable.


                                       24
<PAGE>   27
                                     PART II

ITEM 5.            MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
                   MATTERS

     Our common stock has been listed on the New York Stock Exchange under the
symbol "TFS" since December 29, 1994. The following table sets forth the
quarterly high and low sales prices of our common stock as reported on the New
York Stock Exchange for the periods indicated, adjusted to reflect the
four-for-three split of our common stock effected in December 1999 and the
three-for-two split of our common stock effected in May 2000.

<TABLE>
<CAPTION>
                                                       High            Low
1998:                                                  ----            ---
<S>                                                  <C>             <C>
  First Quarter..................................    $ 11.53         $  8.88
  Second Quarter.................................      10.19            7.44
  Third Quarter..................................       9.09            3.53
  Fourth Quarter.................................       6.94            3.25

1999:
  First Quarter..................................    $  8.00         $  4.31
  Second Quarter.................................       6.91            4.03
  Third Quarter..................................      11.06            6.84
  Fourth Quarter.................................      27.33           11.13

2000:
  First Quarter..................................    $ 43.71         $ 25.46
  Second Quarter.................................      80.75           36.75
  Third Quarter..................................      67.25           24.00
  Fourth Quarter.................................      39.06           16.44

2001:
  First Quarter (through March 12, 2001) ........    $ 27.23         $ 15.30
</TABLE>

     As of March 12, 2001, there were approximately 740 holders of record of our
common stock. The closing sale price of our common stock on the New York Stock
Exchange on March 12, 2001 was $15.33 per share.

     Our policy is to retain earnings to provide funds for the operation and
expansion of our business. We have not paid cash dividends on our common stock
and do not anticipate that we will do so in the foreseeable future. Furthermore,
our credit facility with Imperial Bank does not permit us to pay dividends
without the consent of Imperial Bank. The payment of dividends in the future
will depend on our growth, profitability, financial condition, and other factors
that our board of directors may deem relevant.


                                       25
<PAGE>   28
ITEM 6.            SELECTED FINANCIAL DATA

     The selected historical financial data presented below are derived from our
consolidated financial statements, which have been audited by Arthur Andersen
LLP, independent public accountants. The selected financial data should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
and the Notes thereto included elsewhere in this report. All share amounts and
per share data have been adjusted to reflect the four-for-three split of our
common stock effected in December 1999 and the three-for-two split of our common
stock effected in May 2000.

<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,
                                                         ----------------------------------------------------------
                                                            1996        1997        1998         1999        2000
                                                            ----        ----        ----         ----        ----
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
<S>                                                      <C>         <C>          <C>         <C>          <C>
Net sales............................................    $  60,713   $  84,642    $  95,047   $ 147,408    $160,684
                                                         ---------   ---------    ---------   ---------    --------
Costs and expenses:
 Cost of sales.......................................       58,321      64,760       76,149     117,583     124,724
 Selling, general, and administrative................        5,351       6,557        7,334      11,170       9,501
 Research, development, and engineering..............        4,065       5,106        7,159       8,745      13,295
                                                         ---------   ---------    ---------   ---------    --------
                                                            67,737      76,423       90,642     137,498     147,520
                                                         ---------   ---------    ---------   ---------    --------
Operating income (loss)..............................       (7,024)      8,219        4,405       9,910      13,164
Other income (expense), net..........................          273         358          (42)        (18)      7,184
                                                         ---------   ---------    ---------   ---------    --------
Income (loss) before provision for (benefit from) income
  taxes..............................................       (6,751)      8,577        4,363       9,892      20,348
Provision for (benefit from) income taxes............       (2,920)      3,334        1,773       2,968       5,514
                                                         ---------   ---------    ---------   ---------    --------
Net income (loss)....................................    $  (3,831)   $  5,243    $   2,590   $   6,924     $14,834
                                                         =========   =========    =========   =========     =======
Earnings (loss) per common share:
   Basic.............................................    $   (0.25)  $    0.33    $    0.17   $    0.44     $  0.73
                                                         =========   =========    =========   =========     =======
   Diluted...........................................    $   (0.25)  $    0.32    $    0.17   $    0.43     $  0.69
                                                         =========   =========    =========   =========     =======
Weighted average number of common shares:
   Basic.............................................       15,536      15,708       15,277      15,563      20,457
                                                         =========   =========    =========   =========     =======
   Diluted...........................................       15,536      16,180       15,604      16,005      21,636
                                                         =========   =========    =========   =========     =======
</TABLE>


<TABLE>
<CAPTION>
                                                                                 DECEMBER 31,
                                                         ---------------------------------------------------------
                                                            1996        1997        1998         1999        2000
                                                            ----        ----        ----         ----        ----
                                                                                 (IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
<S>                                                       <C>        <C>           <C>       <C>         <C>
Working capital......................................     $  21,513  $  29,113     $24,825   $  60,853   $194,492
Total assets.........................................        62,569     72,835      77,904     126,930    267,843

Notes payable to banks, term loans
  and long-term debt.................................            --         --       8,095          --      2,706

Stockholders' equity.................................        51,184     56,525      51,096     101,220    242,002
</TABLE>


                                       26
<PAGE>   29
ITEM 7.            MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                   AND RESULTS OF OPERATIONS

OVERVIEW

     We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We specialize in custom display
modules utilizing liquid crystal display, or LCD, components and technology. Our
LCD modules have varying levels of integration. At a minimum, each module
includes an LCD, a custom LCD driver, and a flexible connector. We also provide
value-added services, which increase our competitiveness, by assembling
additional components onto the module based upon the specific needs of the
customer. These additional components include such items as keypads,
microphones, speakers, light guides, and optics.

     We currently sell substantially all of our LCD modules to major OEMs. We
derived more than 80% of our net sales in 1999 and 2000 from the mobile handset
market. When we win a design program, our customer typically pays all or a
portion of our nonrecurring engineering expenses to defray the costs of custom
design, as well as the costs of nonrecurring tooling for custom components. The
typical design program life cycle of a custom-designed LCD module is three to
twelve months and includes technical design, prototyping, pilot manufacturing,
and high-volume manufacturing. We typically seek large volume programs from
major OEMs. The minimum production quantity for an LCD module typically
approximates 100,000 units per year, although the production rate for some
programs has been as high as 100,000 units per week. The selling price of our
LCD modules usually ranges between $5 and $20 per unit. We recognize revenue
when persuasive evidence of an arrangement exists, delivery has occurred, the
fee is fixed or determinable and collectability is probable. Generally, all of
these conditions are met at the time we ship products to customers.

     We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer was
Motorola. In 1996, our net sales declined, primarily as a result of the
phase-out by Motorola of a significant family of programs. In 1997, our net
sales returned to pre-1996 levels primarily as a result of several new programs
and customers. Motorola accounted for 34.6% of our net sales in 1997, 63.6% in
1998, 86.1% in 1999, and 86.9% in 2000.

     During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the year
following holiday sales. As a result, sales usually peak in the fourth quarter
of a calendar year and are lower in the following quarter. This pattern did not
occur in 2000 as a result of supply interruptions in the fourth quarter and
reduced expectations in the mobile handset market.

     Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing. Currently, significant pricing
pressure exists in the LCD module market, especially in higher volume programs
in the wireless communications industry. Accordingly, as the production levels
of some of our new higher volume programs have increased, the lower standard
gross margins on those programs have impacted, and will continue to impact, our
overall margins.

     We vertically integrate our manufacturing facilities. In Arizona, we own
and operate the largest high-volume LCD production line in North America. We
generally use the Arizona facility for the manufacture of more technologically
complex and custom high-volume LCDs. We also purchase LCDs from Asian and
European sources to provide us an alternate source and to ensure available
capacity. In order to take advantage of lower labor costs, we ship our LCDs to
our facilities in Manila, the Philippines, or Beijing, China, for assembly into
modules.

     In Manila, we assemble LCDs into modules and perform certain back-end LCD
processing operations. We conduct our operations in Manila through a third-party
subcontract manufacturer. The subcontractor supplies direct labor and incidental
services required to manufacture our products. All indirect manufacturing
employees, primarily technicians, supervisors, and engineers, are our employees.
In July 2000, we exercised our right to terminate the subcontract agreement with
the third-party subcontractor, but are negotiating to have in place a new
sub-assembly agreement for that factory by the end of the first quarter of 2001.
In May 2000, we signed a lease for a build-to-suit factory in Manila. The term
of the lease for this second factory in Manila is 125 months starting upon the


                                       27
<PAGE>   30
completion of the factory, expected to be by the end of the first quarter of
2001. At this second factory, we will be employing our own employees and will
not be employing the services of the third-party subcontractor.

     In 1998, we opened a temporary manufacturing facility in Beijing and
commenced construction of a permanent Beijing facility. The permanent facility
was substantially completed in early July 1999, and we began production in that
new manufacturing facility late in the third quarter of 1999. All production in
Beijing beginning in the fourth quarter of 1999 was conducted at our new
permanent facility. We own our Beijing facility through a wholly owned foreign
subsidiary. We employ our own employees in Beijing and do not employ the
services of a third-party subcontractor.

     Selling, general, and administrative expense consists principally of
administrative and selling costs, salaries, commissions, and benefits to
personnel and related facility costs. We make substantially all of our sales
directly to OEMs, and our sales force consists of a small number of direct
technical sales persons. As a result, there is no material cost of distribution
in our selling, general, and administrative expense. Selling, general, and
administrative expense has increased as we have expanded our business and
increased our diversification efforts. In addition, we have recently incurred
substantial marketing and administrative expenses in connection with our LCoS
microdisplay business.

     Research, development, and engineering expense consists principally of
salaries and benefits to scientists, design engineers, and other technical
personnel, related facility costs, process development costs, and various
expenses for projects, including new product development. Research, development,
and engineering expense continues to increase as we develop new display products
and technologies, especially LCoS microdisplays, while we continue with our
in-house process development efforts related to the high-volume LCD
manufacturing line located in Arizona.

     Since 1997, we have been working on the development of LCoS microdisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoS microdisplay products. Under that
alliance, National focused on the silicon technologies needed for microdisplays,
and we focused on the liquid crystal technologies. In 1999, National decided to
close its microdisplay business unit. In connection with that closing, in July
1999, we purchased certain assets and licensed silicon technologies from
National relating to LCoS microdisplays. We paid approximately $3.0 million in
cash and issued warrants to purchase 140,000 shares of our common stock in the
transaction, which valued the transaction at approximately $3.6 million. No
additional payments are required under the licenses. We also hired several key
technical employees of National to assist in the implementation of the acquired
technologies.

     In April 1998, we entered into a strategic relationship with Inviso, Inc.,
formerly Siliscape, Inc., a privately held company with numerous patents and
proprietary technology related to microdisplay development. We acquired a
minority equity interest in Inviso for approximately $3.3 million. In March
2000, we acquired an additional interest in Inviso for $500,000, raising our
total minority equity interest to $3.8 million. As part of this strategic
relationship, we provide proprietary manufacturing capabilities and liquid
crystal expertise, and Inviso provides patented and proprietary technologies and
components for the joint development of microdisplay products.

     In August 1999, we licensed the microdisplay technology of S-Vision
Corporation, which had recently ceased operations. This license is an
irrevocable, royalty free, fully paid-up, worldwide license to manufacture and
package certain microdisplay products and patented optical engines.

     In October 1999, we entered into an agreement with Tecdis S.p.A., a
European-based LCD company, to form an ASIC design center in Chatillon, Italy.
The ASIC design center will be known as Dora and will focus on the design of
ASICs necessary to drive the LCDs we and Tecdis design for our respective
customers. STMicroelectronics is also participating in Dora and has agreed to
manufacture the ASICs designed by Dora.

     In August 2000, our wholly owned subsidiary, Three-Five Systems (Beijing)
Co., Ltd., entered into a strategic agreement with Heibei Jiya Electronics, Co.,
Ltd. (Jiya), a Chinese-based manufacturer of LCD glass. Under the terms of the
agreement, Jiya will provide LCD glass to us and reserve a significant amount of
LCD glass manufacturing capacity for us. In exchange, we will assist Jiya in
further developing its LCD glass manufacturing processes. At the conclusion of
18 months, we have the option to extend the agreement or to acquire a majority
interest in Jiya.


                                       28
<PAGE>   31
     These acquisitions, investments, and licenses will result in increased
research, development, and engineering expense as we expand our LCoS
microdisplay development efforts in preparation for the commercial introduction
of LCoS microdisplay products. We are also considering licensing other
technologies from other companies that could be optimized on our LCD
manufacturing line as well as entering into further alliances. We expect to
continue to devote substantial resources to research and development, especially
on our LCoS microdisplay technology and related products. As a result, the
actual dollar amount of our research, development, and engineering expense will
continue to increase.

RESULTS OF OPERATIONS

     The following table sets forth, for the periods indicated, the percentage
of net sales of certain items in our Consolidated Financial Statements.

<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                            --------------------------------------------
                                                             1998              1999               2000
                                                             ----              ----               ----
<S>                                                          <C>               <C>                <C>
Net sales...........................................         100.0%            100.0%             100.0%
                                                            ------            ------            -------
Costs and expenses:
  Cost of sales.....................................          80.1              79.8               77.6
  Selling, general, and administrative..............           7.7               7.6                5.9
  Research, development, and engineering............           7.6               5.9                8.3
                                                            ------            ------            -------
                                                              95.4              93.3               91.8
                                                            ------            ------            -------
Operating income....................................           4.6               6.7                8.2
Other income, net...................................            --                --                4.5
                                                            ------            ------            -------
Income before provision for income taxes............           4.6               6.7               12.7
Provision for income taxes..........................           1.9               2.0                3.5
                                                            ------            ------            -------
Net income..........................................           2.7%              4.7%               9.2%
                                                            ======            ======            =======
</TABLE>


Year ended December 31, 2000 compared to year ended December 31, 1999

     NET SALES. Net sales increased 9.0% to $160.7 million in 2000 from $147.4
million in 1999. This increase was the result of several new programs, primarily
for Motorola.

     COST OF SALES. Cost of sales decreased to 77.6% of net sales in 2000 from
79.8% in 1999. This percentage decrease resulted primarily from increased
operating efficiencies in the first half of 2000 and cost reduction efforts.
Pricing pressures and under-absorption issues resulting from decreased
production levels in the second half of 2000 actually resulted in a sharp
increase in the cost of sales in the second half of 2000, especially in the
fourth quarter.

     SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE. Selling, general, and
administrative expense decreased 15.2% to $9.5 million in 2000 from $11.2
million in 1999. Selling, general, and administrative expense was 5.9% of net
sales in 2000 compared to 7.6% in 1999. The decrease in selling, general, and
administrative expense was a result of our efforts to hold down costs.

     RESEARCH, DEVELOPMENT, AND ENGINEERING EXPENSE. Research, development, and
engineering expense increased 52.9% to $13.3 million in 2000 from $8.7 million
in 1999. Research, development, and engineering expense was 8.3% of net sales in
2000 compared to 5.9% in 1999. In general, research, development, and
engineering expense overall increased as the result of the development of new
display products and technologies, including LCoS microdisplays. Expenses also
increased in LCD engineering as a result of the increased number of design wins.

     The selling, general and administrative expense and the research,
development and engineering expense in each year included significant operating
expenditures in LCoS microdisplays at a time when there was very little LCoS
microdisplay revenue. In 2000, we incurred approximately $9.4 million of
operating expenses specifically related to LCoS microdisplays compared to
approximately $6.6 million in 1999.

     OTHER INCOME (EXPENSE), NET. Other income in 2000 was $7.2 million compared
to other expense of $18,000 in 1999. We had sharply higher interest income and
reduced interest expense in 2000 as the result of


                                       29
<PAGE>   32
decreased debt and increased cash and investment balances. Those increased cash
and investment balances were primarily as a result of our equity offering in May
2000.

     PROVISION FOR INCOME TAXES. We recorded a provision for income taxes of
$5.5 million in 2000 compared to $3.0 million in 1999. The effective tax rate
was 27.1% in 2000 compared to 30.0% in 1999. This change resulted primarily from
tax benefits in the third and fourth quarters of 2000 relating to research and
development tax credits. Generally, the tax rate was also lower in 2000 as a
result of higher net income in China (which is a low tax rate jurisdiction). In
2001, we expect our overall tax rate to be approximately 33.0%.

     NET INCOME. Net income increased 114.5% to $14.8 million, or $0.69 per
diluted share, in 2000 from $6.9 million, or $0.43 per diluted share, in 1999.
Excluding LCoS microdisplay related expenses, our net income was approximately
$20.9 million, or $0.97 per diluted share.

Year ended December 31, 1999 compared to year ended December 31, 1998

     NET SALES. Net sales increased 55.2% to $147.4 million in 1999 from $95.0
million in 1998. This increase resulted from several new programs, primarily for
Motorola. Net sales in the fourth quarter of 1999 were 117.2% greater than net
sales in the first quarter of 1999.

     COST OF SALES. Cost of sales decreased to 79.8% of net sales in 1999 from
80.1% in 1998. This percentage decrease resulted primarily from increased
operating efficiencies as a result of a significant increase in production
volume. Most of those operating efficiencies occurred in the fourth quarter of
1999. In addition, our permanent China manufacturing facility was operational
during the entire fourth quarter, and in that new facility we experienced better
yields and absorption than when we operated in our temporary China facility.

     SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE. Selling, general, and
administrative expense increased 53.4% to $11.2 million in 1999 from $7.3
million in 1998. Selling, general, and administrative expense was 7.6% of net
sales in 1999 compared to 7.7% in 1998. The increase in selling, general, and
administrative expense reflected the continued expansion of our business,
especially in LCoS microdisplays.

     RESEARCH, DEVELOPMENT, AND ENGINEERING EXPENSE. Research, development, and
engineering expense increased 20.8% to $8.7 million in 1999 from $7.2 million in
1998. Research, development, and engineering expense was 5.9% of net sales in
1999 compared to 7.6% in 1998. Although research, development, and engineering
expense associated with in-process developments on the LCD line decreased in
1999, research, development, and engineering expense overall increased as the
result of the development of new display products and technologies, including
LCoS microdisplays.

     The selling, general and administrative expense and the research,
development and engineering expenses in each year included operating expenses in
LCoS microdisplays at a time when there was very little microdisplay revenue. In
1999, we incurred approximately $6.6 million of operating expenses specifically
related to LCoS microdisplays compared to approximately $2.7 million in 1998.

     OTHER INCOME (EXPENSE), NET. Other expense was $18,000 in 1999 compared to
$42,000 in 1998. We had sharply higher interest income in the fourth quarter of
1999 as a result of increased cash balances and a tax refund. That interest
income offset interest expense we had in the first three quarters of 1999 as a
result of additional borrowing incurred in connection with our stock repurchase
program and increased borrowings on our working capital line of credit. All
credit lines were paid off and cash balances increased as a result of our equity
offering in the third quarter of 1999.

     PROVISION FOR INCOME TAXES. We recorded a provision for income taxes of
$3.0 million in 1999 compared to $1.8 million in 1998. This change resulted
primarily from higher pre-tax income in 1999 compared to the same period in
1998. In addition, we recorded tax benefits in the first and fourth quarters of
1999 relating to a state income tax refund. Generally, the tax rate was also
lower in 1999 as a result of higher net income in China (which is a low tax rate
jurisdiction) compared to a net loss in China in 1998.


                                       30
<PAGE>   33
     NET INCOME. Net income increased 165% to $6.9 million, or $0.43 per diluted
share, in 1999 from $2.6 million, or $0.17 per diluted share, in 1998. Excluding
LCoS microdisplay related expenses, our net income for 1999 was approximately
$11.4 million, or $0.71 per diluted share.

QUARTERLY RESULTS OF OPERATIONS

     The following table presents unaudited consolidated statement of operations
data for each of the eight quarters in the period ended December 31, 2000, as
well as such data expressed as a percentage of net sales. We believe that all
necessary adjustments have been included to present fairly the quarterly
information when read in conjunction with the Consolidated Financial Statements.
The operating results for any quarter are not necessarily indicative of the
results for any subsequent quarter.


<TABLE>
<CAPTION>
                                                                  QUARTERS ENDED
                               ----------------------------------------------------------------------------------
                                                                  (IN THOUSANDS)
                                                 1999                                       2000
                               -----------------------------------------  ---------------------------------------
                               MAR. 31    JUNE 30   SEPT. 30   DEC. 31    MAR. 31    JUNE 30   SEPT. 30   DEC. 31
                               -------    -------   --------   -------    -------    -------   --------   -------
<S>                            <C>        <C>       <C>        <C>        <C>        <C>       <C>        <C>
Net sales.................     $23,044    $31,600   $42,723    $50,041    $39,162    $44,926   $40,231    $36,365
                               -------    -------   -------    -------    -------    -------   -------    -------
Cost and expenses:
  Cost of sales...........      20,191     25,103    33,882     38,407     29,360     34,157    31,115     30,092
  Selling, general, and
    administrative........       2,449      2,493     2,741      3,487      2,262      2,418     2,453      2,368
  Research, development,
    and engineering.......       1,821      2,008     2,427      2,489      2,763      2,989     3,734      3,809
                               -------     ------   -------    -------    -------    -------   -------    -------
                                24,461     29,604    39,050     44,383     34,385     39,564    37,302     36,269
                               -------     ------   -------    -------    -------    -------   -------    -------
Operating income (loss)...      (1,417)     1,996     3,673      5,658      4,777      5,362     2,929         96
Other income (expense), net       (185)      (214)     (160)       541        580      1,165     2,736      2,703
                               -------     ------   -------    -------    -------    -------   -------    -------
Income (loss) before
  provision for (benefit
  from) income taxes......      (1,602)     1,782     3,513      6,199      5,357      6,527     5,665      2,799
Provision for (benefit from)
  income taxes............        (960)       742     1,476      1,710      1,770      2,158     1,320        266
                               -------     ------   -------    -------    -------    -------   -------    -------
Net income (loss).........     $  (642)    $1,040   $ 2,037    $ 4,489    $ 3,587    $ 4,369   $ 4,345    $ 2,533
                               =======     ======   =======    =======    =======    =======   =======    =======
</TABLE>

<TABLE>
<CAPTION>
                                                             PERCENTAGE OF NET SALES
                               ----------------------------------------------------------------------------------
                                                                  QUARTERS ENDED
                                                 1999                                       2000
                               ---------------------------------------    ---------------------------------------
                               MAR. 31    JUNE 30   SEPT. 30   DEC. 31    MAR. 31    JUNE 30   SEPT. 30   DEC. 31
                               -------    -------   --------   -------    -------    -------   --------   -------
<S>                              <C>        <C>       <C>       <C>         <C>        <C>       <C>       <C>
Net sales.................       100.0%     100.0%    100.0%    100.0%      100.0%     100.0%    100.0%    100.0%
                                 -----      -----     -----     -----       -----      -----     -----     -----
Cost and expenses:
  Cost of sales...........        87.6       79.4      79.3      76.8        75.0       76.0      77.3      82.7
  Selling, general, and
    administrative........        10.6        7.9       6.4       6.9         5.7        5.4       6.1       6.5
  Research, development,
    and engineering ......         7.9        6.4       5.7       5.0         7.1        6.7       9.3      10.5
                               -------    -------   -------    ------     -------    -------   -------    ------
                                 106.1       93.7      91.4      88.7        87.8       88.1      92.7      99.7
Operating income (loss)...        (6.1)       6.3       8.6      11.3        12.2       11.9       7.3       0.3
Other income (expense), net       (0.9)      (0.7)     (0.4)      1.1         1.5        2.6       6.8       7.4
                               -------    -------   -------    ------     -------    -------   -------    ------
Income (loss) before
  provision for (benefit
  from) income taxes......        (7.0)       5.6       8.2      12.4        13.7       14.5      14.1       7.7
Provision for (benefit from)
  income taxes............        (4.2)       2.3       3.4       3.4         4.5        4.8       3.3       0.7
                               -------    -------   -------    ------     -------    -------   -------    ------
Net income (loss).........        (2.8)%      3.3%      4.8%      9.0%        9.2%       9.7%     10.8%      7.0%
                                =======    =======   =======    ======     =======    =======   =======    ======
</TABLE>


     Historically, we have experienced seasonal fluctuations in our net sales.
OEM customers that purchase our products for incorporation into retail products,
such as mobile handsets, typically increase their purchases during the year-end
holiday period and phase out old programs early in the year following holiday
sales. As a result, net sales typically peak in the fourth quarter and reach a
seasonal low point in the first quarter. This pattern did not occur in 2000 as a
result of supply interruptions in the fourth quarter and reduced expectations in
the mobile handset market.

     There is significant pricing pressure in higher volume programs in the
wireless communications and office automation industries. In the first quarter
of 1999, we had an unfavorable product mix, shipping principally lower margin
products. In addition, reduced manufacturing yields and under-absorption of
fixed overhead contributed to


                                       31
<PAGE>   34
lower margins. In the second half of 1999, higher volumes in our manufacturing
facilities produced increased operating efficiencies, resulting in better
margins. In addition, we moved into our permanent facility in China in the third
quarter of 1999 and, as a result, operating efficiencies increased in China in
the fourth quarter of 1999.

     The higher gross margins continued into the first half of 2000 as a result
of continued efficiencies. As revenue declined in the second half of 2000,
absorption issues from the reduced manufacturing levels resulted in lowered
margins. In addition, pricing pressures in the mobile handset business also
contributed to the reduced gross margins.

     In 1999, we continued to expand and intensify our research and development
efforts on proprietary display products, such as LCoS microdisplays. Other
expense increased in the first half of 1999 as our cash balances declined and we
increased our borrowings. All borrowings were paid off and cash balances
increased as a result of our equity offering in the third quarter of 1999. As a
result, we had sharply higher interest income in the fourth quarter of 1999. In
the second quarter of 2000, we had another equity offering, which further raised
our cash, cash equivalents and short-term investments and increased our interest
income in 2000.

LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 2000, we had cash, cash equivalents and short-term
investments of $165.6 million compared to cash and cash equivalents of $45.4
million at December 31, 1999.

     In 2000, we had $6.1 million in net cash flow from operations compared to
$18.4 million from operations in 1999. Cash flow from operations during 2000 was
lower than 1999 primarily as a result of increased inventories. Inventories were
lower than normal at the end of 1999 because of material component shortages. In
addition, an increased backlog at the end of 2000 resulted in higher inventory
balances. As of December 31, 2000, our inventory turns were 7.6 and DSOs (Day
Sales Outstanding) were 54 days. Our depreciation expense was $6.0 million in
2000 compared to $5.9 million in 1999.

     Our working capital was $194.5 million at December 31, 2000, up from $60.9
million at December 31, 1999. Our current ratio at December 31, 2000 was
10.1-to-1 compared to 3.8-to-1 at December 31, 1999. The increase in our working
capital and current ratio occurred primarily because of our equity offering in
the second quarter of 2000, in which we sold approximately 2.5 million shares of
common stock for approximately $128.7 million.

     In January 2000, we entered into a credit facility with Imperial Bank. That
credit facility was a $25.0 million unsecured revolving line of credit that
matured in January 2001. Mellon Bank was a participating lender on that credit
facility. No borrowings were outstanding under that credit facility on December
31, 2000. In January 2001, we amended and revised that facility to reduce it to
$15.0 million and eliminated Mellon Bank as a participating lender. Advances
under the new facility may be made as prime rate advances, which accrue interest
payable monthly at the bank's prime lending rate, or as LIBOR rate advances,
which bear interest at 150 basis points in excess of the LIBOR base rate. Our
United Kingdom Three-Five Systems Limited subsidiary has established an annually
renewable credit facility with a United Kingdom bank in order to fund its
working capital requirements. The credit facility, which expires January 15,
2002, provides $350,000 of borrowing capacity secured by accounts receivable of
Three-Five Systems Limited. No borrowings are outstanding under this facility.
As of December 31, 2000, our Beijing subsidiary had an outstanding $2.7 million
term loan due May 4, 2001 to the Bank of China, which was secured by a $3.0
million stand-by letter of credit issued by Imperial Bank.

     Capital expenditures during 2000 were approximately $8.8 million. Those
capital expenditures consisted of $6.4 million for equipment and leasehold
improvement costs in Manila, Beijing and Arizona, and $2.4 million for LCoS
microdisplays. We also made an additional investment in Inviso of $500,000.
Capital expenditures during 1999 were approximately $12.5 million. These capital
expenditures consisted of $5.6 million for equipment and construction costs
relating to our manufacturing facility in Beijing; $1.8 million for
manufacturing and office equipment for our operations in Manila and Arizona; and
$5.1 million for LCoS microdisplays, including our purchase of assets and
licenses from National Semiconductor and S-Vision. The assets and licensed
silicon technologies from National Semiconductor relating to LCoS microdisplays
were acquired for approximately $3.0 million in cash and warrants to purchase
140,000 shares of our common stock. Substantially all of the purchase price was
allocated to depreciable assets, tooling and mask rights, and amortizable
licenses.


                                       32
<PAGE>   35
     We believe that our existing balances of cash, cash equivalents,
investments, anticipated cash flows from operations and available and
anticipated credit lines will provide adequate sources to fund our operations
and planned expenditures through 2001. We may have to expand our loan
commitments or pursue alternate methods of financing or raise capital, however,
should we encounter additional cash requirements. For example, accounts
receivable and inventory could rise faster than anticipated if revenue levels
increase more than currently anticipated. In addition, we will continue to seek
other alliances or acquisitions and additional relationships with regard to the
strategic development of various new technologies, especially LCoS
microdisplays, that may also require us to make additional capital investments.
We cannot provide assurance that adequate additional loan commitments or
alternative methods of financing will be available or, if available, that they
will be on terms acceptable to us.

IMPACT OF RECENTLY ISSUED STANDARDS.

     In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. In June 1999, the FASB issued SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB No. 133. In June 2000, the FASB issued SFAS No. 138,
Accounting for Certain Derivative Instruments and Certain Hedging Activities, an
amendment of SFAS No. 133. SFAS No. 133, as amended, establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
No. 133 requires that changes in the derivative instrument's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative instrument's
gains and losses to offset related results on the hedged item in the income
statement, to the extent effective, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133, as amended, is effective for fiscal years
beginning after June 15, 2000. SFAS No. 133 cannot be applied retroactively. We
plan to adopt SFAS No. 133 on January 1, 2001.

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101), which addresses certain criteria for revenue recognition. SAB 101, as
amended by SAB 101A and SAB 101B, outlines the criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. We have implemented the applicable provisions of SAB 101.
The impact of adopting the provisions of SAB 101 was not material to the
accompanying financial statements.

     In July 2000, the Emerging Issues Task Force (EITF) reached a final
consensus on Issue No. 00-10, Accounting for Shipping and Handling Fees and
Costs. When adopted, EITF No. 00-10 requires that all amounts billed to
customers in sale transactions related to shipping and handling be classified as
revenue. We adopted EITF No. 00-10 during our quarter ended September 30, 2000.
The impact of the adoption was not material to the accompanying financial
statements for any period presented.

     During March 2000, the FASB issued FASB Interpretation No. 44, Accounting
for Certain Transactions involving Stock Compensation - an interpretation of APB
Opinion No. 25 (FIN 44), which, among other issues, addresses repricing and
other modifications made to previously issued stock options. We adopted FIN 44
during July 2000. The adoption of FIN 44 did not have a material impact on our
financial position or results of operations.

ITEM 7A.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments

     At December 31, 2000, we did not participate in any derivative financial
instruments, or other financial and commodity instruments for which fair value
disclosure would be required under Statement of Financial Accounting Standards
No. 107. We hold no investment securities that would require disclosure of
market risk.

     We have certain receivables denominated in Chinese renminbi. To eliminate
our exposure to changes in the U.S. dollar/Chinese renminbi exchange rate, we
have entered into forward contracts to protect future cash flows. Hedge
accounting under current accounting principles generally accepted in the United
States does not require us to record any gain or loss on the forward contracts
until settled. In contrast, under SFAS No. 133, we will designate the forward
contracts as cash flow hedges. We will account for changes in the fair value of
our forward contracts,


                                       33
<PAGE>   36
based on changes in the forward exchange rate, with all changes in fair value
reported in other comprehensive income. Amounts in other comprehensive income
will be reclassified into earnings upon settlement of the forward contract at an
amount that will offset the related transaction gain or loss arising from the
remeasurement and adjust earnings for the cost of the forward contracts.

Primary Market Risk Exposures

     Our primary market risk exposures are in the areas of interest rate risk
and foreign currency exchange rate risk. We have a revolving line of credit with
a variable interest rate of LIBOR (6.0% at December 31, 2000) plus 150 basis
points. At December 31, 2000, no borrowings were outstanding under this line of
credit.

     We generally sell our products and services and negotiate purchase orders
with our foreign suppliers in U.S. dollars. However, we have certain foreign
currency exchange exposure as a result of our manufacturing operations in the
Philippines and China and our sales and distribution facility in the United
Kingdom. The third-party subcontractor agreement relating to our operations in
Manila is based on a fixed conversion rate, exposing us to exchange rate
fluctuations with the Philippine peso. We have not incurred any material
exchange gains or losses to date. Some of the expenses of these foreign
operations are denominated in the Philippine peso, Chinese renminbi, and British
pound sterling, respectively. These expenses include local salaries and wages,
utilities, and some operating supplies. As a result of these sales and expenses,
we do have accounts receivable and cash deposits in local currencies. We
believe, however, that the operating expenses currently incurred in foreign
currencies other than the Chinese renminbi are immaterial, and therefore any
associated market risk is unlikely to have a material adverse effect on our
business, results of operations, or financial condition. Although the Chinese
currency currently is stable, its value in relation to the U.S. dollar is
determined by the Chinese government. There is general speculation that China
may devalue its currency. Devaluation of the Chinese currency could result in
translation adjustments to our balance sheet as well as reportable losses
depending on our monetary balances and outstanding indebtedness at the time of
devaluation. The government of China historically has made it difficult to
convert its local currency into foreign currencies. Although we from time to
time may enter into hedging transactions in order to minimize our exposure to
currency rate fluctuations, the Chinese currency is not freely traded and thus
is difficult to hedge. In addition, the government of China has recently imposed
restrictions on Chinese currency loans to foreign-operated entities in China.
Based on the foregoing, we cannot provide assurance that fluctuations and
currency exchange rates in the future will not have an adverse effect on our
operations.

ITEM 8.            FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Reference is made to the financial statements, the report thereon, the
notes thereto, and the supplementary data commencing at page F-1 of this Report,
which financial statements, report, notes, and data are incorporated herein by
reference.

ITEM 9.            CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                   AND FINANCIAL DISCLOSURE

         Not applicable.

                                    PART III

ITEM 10.           DIRECTORS AND EXECUTIVE OFFICERS

     The information required by this Item relating to our directors is
incorporated by reference to the definitive Proxy Statement to be filed pursuant
to Regulation 14A of the Exchange Act for our 2001 Annual Meeting of
Stockholders. The information required by this Item relating to our executive
officers is included in Item 1, "Business - Executive Officers" of this report.

ITEM 11.           EXECUTIVE COMPENSATION

     The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2001 Annual Meeting of Stockholders.


                                       34
<PAGE>   37
ITEM 12.           SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                   MANAGEMENT

     The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2001 Annual Meeting of Stockholders.

ITEM 13.           CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2001 Annual Meeting of Stockholders.


                                       35
<PAGE>   38
                                     PART IV

ITEM 14.           EXHIBITS AND REPORTS ON FORM 8-K

(A)  FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

     (1)  Financial Statements are listed in the Index to Financial Statements
          on page F-1 of this Report.
     (2)  Financial Statement Schedule:

     Schedule II Valuation and Qualifying Accounts and Reserves is set forth on
page S-2 of this Report.

     Other schedules are omitted because they are not applicable, not required,
or because required information is included in the consolidated financial
statements or notes thereto.

(B)  REPORTS ON FORM 8-K

     Not  applicable.

(C)  EXHIBITS

EXHIBIT
NUMBER      EXHIBITS
-------     --------
2           Amended and Restated Agreement and Plan or Reorganization(1)

3(a)        Amended and Restated Certificate of Incorporation of the Company(2)

3(b)        Certificate of Amendment of Restated Certificate of Incorporation(3)

3(c)        Amended and Restated Bylaws of the Company(4)

4           Form of Certificate of Common Stock(4)

10(a)       Amended and Restated 1997 Employee Option Plan (as amended through
            August 2000)(5)

10(c)       Line of Credit Agreement between Three-Five Systems Limited and
            Barclays Bank, PLC(1)

10(g)       Form of Three-Five Systems, Inc. Distributor Franchise Agreement(6)

10(j)       1993 Stock Option Plan(6)

10(k)       1994 Automatic Stock Option Plan(7)

10(o)       Lease dated April 1, 1994, between Papago Park Center, Inc. and
            Three-Five Systems, Inc.(8)

10(v)       1997 Employee Stock Option Agreement(9)

10(w)       Amended and Restated Three-Five Systems, Inc. 1998 Stock Option
            Plan, amended as of January 28, 1999, as approved by the Company's
            stockholders on April 22, 1999(10)

10(x)       Amended and Restated Directors' Stock Plan(11)

10(z)       401(k) Profit Sharing Plan(12)

10(aa)      Credit Agreement dated January 21, 2000, by and among Three-Five
            Systems, Inc., its subsidiaries, the Banks named therein, and
            Imperial Bank Arizona, as Agent and as Issuing Bank(11)

10(cc)      Modification Agreement dated February 1, 2001, by and among
            Three-Five Systems, Inc., its subsidiaries, the Banks named in the
            Credit Agreement, and Imperial Bank as administrative agent and as
            Issuing Bank

21          List of Subsidiaries(4)

23          Consent of Arthur Andersen LLP


(1)  Incorporated by reference to the Registration Statement on Form S-4 of TF
     Consolidation, Inc. (Registration No. 33-33944) as filed March 27, 1990 and
     declared effective March 27, 1990.

(2)  Incorporated by reference to the Registrant's Form 10-QSB for the quarter
     ended March 31, 1994, as filed with the Commission on or about May 12,
     1994.

(3)  Incorporated by reference to the Registrant's Form S-3/A as filed with the
     Commission on May 5, 2000.

(4)  Incorporated by reference to the Registration Statement on Form S-3
     (Registration No. 333-84083) as filed on July 30, 1999, as amended by Form
     S-3/A filed on August 26, 1999, and declared effective September 27, 1999.

(5)  Incorporated by reference to the Registrant's Form S-8 as filed with the
     Commission on November 3, 2000.


                                       36
<PAGE>   39
(6)  Incorporated by reference to the Registration Statement on Form S-1
     (Registration No. 33-74788) as filed on February 3, 1994, and declared
     effective March 15, 1994.

(7)  Incorporated by reference to the Registration Statement on Form S-8
     (Registration No. 33-88706) as filed on January 24, 1995.

(8)  Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1996, as filed with the Commission on March 14, 1997.

(9)  Incorporated by reference to the Registrant's Form 10-K for the fiscal year
     ended December 31, 1997, as filed with the Commission on March 13, 1998,
     and as amended by Form 10-K/A filed with the Commission on March 23, 1998.

(10) Incorporated by reference to the Registration Statement on Form S-8
     (Registration No. 333-87875) as filed on September 27, 1999.

(11) Incorporated by reference to the Registrant's Form 10-Q for the quarter
     ended June 30, 2000, as filed with the Commission on July 27, 2000.

(12) Incorporated by reference to the Registration Statement on Form S-8
     (Registration No. 333-57933) as filed on June 26, 1998.


                                       37
<PAGE>   40
                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registration has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                                   THREE-FIVE SYSTEMS, INC.



Date:  March 12, 2001              By: /s/ Jack L. Saltich
                                      -----------------------------------------
                                       Jack L. Saltich
                                       President and Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
NAME                                     TITLE                                                 DATE
<S>                                      <C>                                                   <C>
/s/ Jack L. Saltich                      President, Chief Executive Officer                    March 12, 2001
------------------------------------
Jack L. Saltich                          (Principal Executive Officer), and Director

/s/ Jeffrey D. Buchanan                  Executive Vice President, Chief Financial Officer,    March 12, 2001
------------------------------------
Jeffrey D. Buchanan                      Secretary, Treasurer (Principal Financial Officer),
                                         and Director

/s/ Robert T. Berube                     Corporate Controller (Principal Accounting Officer)   March 12, 2001
------------------------------------
Robert T. Berube

/s/ David C. Malmberg                    Director                                              March 12, 2001
------------------------------------
David C. Malmberg

/s/ Gary R. Long                         Director                                              March 12, 2001
------------------------------------
Gary R. Long

/s/ Kenneth M. Julien                    Director                                              March 12, 2001
------------------------------------
Kenneth M. Julien

/s/ Thomas A. Werner                     Director                                              March 12, 2001
------------------------------------
Thomas A. Werner

/s/ David P. Chavoustie                  Director                                              March 12, 2001
------------------------------------
David P. Chavoustie

/s/ Murray Goldman                       Director                                              March 12, 2001
-----------------------------------
Murray Goldman
</TABLE>


                                       38

<PAGE>   41
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
Report of Independent Public Accountants .................................   F-2

Consolidated Balance Sheets as of December 31, 1999 and 2000 .............   F-3

Consolidated Statements of Income for the years ended
  December 31, 1998, 1999, and 2000 ......................................   F-4

Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the years ended December 31, 1998, 1999, and 2000 .............   F-5

Consolidated Statements of Cash Flows for the years ended
  December 31, 1998, 1999 and 2000 .......................................   F-6

Notes to Consolidated Financial Statements ...............................   F-7

Report of Independent Public Accountants .................................   S-1

Schedule II - Valuation and Qualifying Accounts and Reserves
  for the years ended December 31, 1998, 1999 and 2000 ...................   S-2
</TABLE>

                                      F-1
<PAGE>   42
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Three-Five Systems, Inc.:

         We have audited the accompanying consolidated balance sheets of
THREE-FIVE SYSTEMS, INC. (a Delaware corporation) and subsidiaries as of
December 31, 1999 and 2000, and the related consolidated statements of income,
stockholders' equity and comprehensive income and cash flows for each of the
three years in the period ended December 31, 2000. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Three-Five Systems,
Inc., and subsidiaries as of December 31, 1999 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States.


                                               /S/ARTHUR ANDERSEN LLP



Phoenix, Arizona
January 19, 2001


                                      F-2
<PAGE>   43
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

                                                                      DECEMBER 31,
                                                                ------------------------
                                                                  1999           2000
                                                                ---------      ---------
<S>                                                             <C>            <C>
                                ASSETS

Current Assets:
   Cash and cash equivalents ..............................     $  45,363      $  98,876
   Short-term investments .................................            --         66,695
   Accounts receivable, net ...............................        20,886         23,635
   Inventories ............................................        12,344         20,516
   Deferred tax asset .....................................         3,231          4,346
   Other current assets ...................................         1,047          1,778
                                                                ---------      ---------
      Total current assets ................................        82,871        215,846

Long-term Investments .....................................            --          4,534
Property, Plant and Equipment, net ........................        40,546         43,254
Other Assets, net .........................................         3,513          4,209
                                                                ---------      ---------
                                                                $ 126,930      $ 267,843
                                                                =========      =========

                 LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
   Accounts payable .......................................     $  13,450      $  11,404
   Accrued liabilities ....................................         7,526          7,005
   Current taxes payable ..................................         1,042            239
   Term loan ..............................................            --          2,706
                                                                ---------      ---------
      Total current liabilities ...........................        22,018         21,354
                                                                ---------      ---------

Deferred Tax Liability ....................................         3,692          4,487
                                                                ---------      ---------

Commitments and Contingencies

Stockholders' Equity:
   Preferred stock, $.01 par value; 1,000,000 shares
     authorized, no shares issued or outstanding ..........            --             --
   Common stock, $.01 par value; 60,000,000 shares
     authorized, 18,859,138 shares issued, 18,858,549
     shares outstanding at December 31, 1999;
     60,000,000 shares authorized, 21,655,778 shares
     issued, 21,414,258 shares outstanding at
     December 31, 2000 ....................................           189            217
   Additional paid-in capital .............................        67,388        198,215
   Retained earnings ......................................        33,639         48,430
   Cumulative translation adjustment ......................             7           (234)
   Less - Treasury stock, at cost, (589) shares
      at December 31, 1999 and (241,520) shares at December
      31, 2000 ............................................            (3)        (4,626)
                                                                ---------      ---------
         Total stockholders' equity .......................       101,220        242,002
                                                                ---------      ---------
                                                                $ 126,930      $ 267,843
                                                                =========      =========
</TABLE>

              The accompanying notes are an integral part of these
                          consolidated balance sheets.


                                      F-3
<PAGE>   44
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF INCOME
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                YEARS ENDED
                                                                DECEMBER 31,
                                              ------------------------------------------------
                                                  1998              1999              2000
                                              ------------      ------------      ------------
<S>                                           <C>               <C>               <C>
Net Sales ...............................     $     95,047      $    147,408      $    160,684
                                              ------------      ------------      ------------

Costs and Expenses:
   Cost of sales ........................           76,149           117,583           124,724
   Selling, general and administrative ..            7,334            11,170             9,501
   Research, development and engineering             7,159             8,745            13,295
                                              ------------      ------------      ------------
                                                    90,642           137,498           147,520
                                              ------------      ------------      ------------
Operating income ........................            4,405             9,910            13,164
                                              ------------      ------------      ------------

Other Income (Expense):
   Interest, net ........................               75                51             7,374
   Other, net ...........................             (117)              (69)             (190)
                                              ------------      ------------      ------------
                                                       (42)              (18)            7,184
                                              ------------      ------------      ------------
Income before provision for income taxes             4,363             9,892            20,348
   Provision for income taxes ...........            1,773             2,968             5,514
                                              ------------      ------------      ------------
Net income ..............................     $      2,590      $      6,924      $     14,834
                                              ============      ============      ============

Earnings Per Common Share:
   Basic ................................     $       0.17      $       0.44      $       0.73
                                              ============      ============      ============
   Diluted ..............................     $       0.17      $       0.43      $       0.69
                                              ============      ============      ============

Weighted Average Number of Common Shares:
   Basic ................................       15,277,262        15,563,121        20,457,226
                                              ============      ============      ============
   Diluted ..............................       15,604,082        16,005,050        21,635,524
                                              ============      ============      ============
</TABLE>

              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                      F-4
<PAGE>   45
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                            AND COMPREHENSIVE INCOME
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1999, AND 2000
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                       COMMON STOCK                                                          TOTAL
                                  --------------------    ADDITIONAL              CUMULATIVE                 STOCK-       COMPRE-
                                    SHARES                 PAID-IN     RETAINED   TRANSLATION  TREASURY     HOLDERS'      HENSIVE
                                    ISSUED      AMOUNT     CAPITAL     EARNINGS   ADJUSTMENT    STOCK        EQUITY       INCOME
                                  ----------    ------    ----------   --------   -----------  --------    ----------    ---------
<S>                               <C>           <C>       <C>          <C>        <C>          <C>         <C>           <C>
BALANCE, DECEMBER 31, 1997 .....  15,856,046     $158     $ 32,420     $ 24,180      $  20     $  (253)     $  56,525

Net income .....................          --       --           --        2,590         --          --          2,590    $  2,590
Other comprehensive income
    Foreign currency translation
      adjustments ..............          --       --           --           --        (12)         --            (12)        (12)
                                                                                                                         --------
    Comprehensive income .......          --       --           --           --         --          --             --    $  2,578
                                                                                                                         ========

Stock options exercised ........      93,756        1           64           --         --          --             65
Purchase of treasury stock .....          --       --           --           --         --      (8,072)        (8,072)
                                  ----------     ----     --------     --------      -----     -------      ---------
BALANCE, DECEMBER 31, 1998 .....  15,949,802      159       32,484       26,770          8      (8,325)        51,096

Net income .....................          --       --           --        6,924         --          --          6,924    $  6,924
Other comprehensive income
   Foreign currency translation
      adjustments ..............          --       --           --           --         (1)         --             (1)         (1)
                                                                                                                         --------
    Comprehensive income .......          --       --           --           --         --          --             --    $  6,923
                                                                                                                         ========
Stock options exercised ........     150,650        2          184           (1)        --          41            226
Warrants issued ................          --       --          555           --         --          --            555
Tax benefit on stock option
  exercises ....................          --       --           30           --         --          --             30
Sale of common stock, net of
  Offering expenses ............   2,758,686       28       34,135          (54)        --       8,281         42,390
                                  ----------     ----     --------     --------      -----     -------      ---------
BALANCE, DECEMBER 31, 1999 .....  18,859,138      189       67,388       33,639          7          (3)       101,220

Net income .....................          --       --           --       14,834         --          --         14,834    $ 14,834
Other comprehensive income
   Foreign currency translation
      adjustments ..............          --       --           --           --       (241)         --           (241)       (241)
                                                                                                                         --------
    Comprehensive income .......          --       --           --           --         --          --             --    $ 14,593
                                                                                                                         ========
Stock options exercised ........     222,126        2        1,477           --         --          --          1,479
Warrants exercised, net ........     102,014        1           --           --         --          --              1
Tax benefit on stock option
   Exercises ...................          --       --          674           --         --          --            674
Purchase of treasury stock .....          --       --           --           --         --      (4,623)        (4,623)
Sale of common stock, net of
  Offering expenses ............   2,472,500       25      128,676          (43)        --          --        128,658
                                  ----------     ----     --------     --------      -----     -------      ---------
BALANCE, DECEMBER 31, 2000 .....  21,655,778     $217     $198,215     $ 48,430      $(234)    $(4,626)     $ 242,002
                                  ==========     ====     ========     ========      =====     =======      =========
</TABLE>

              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                      F-5
<PAGE>   46
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                        YEARS ENDED
                                                                                        DECEMBER 31,
                                                                            -------------------------------------
                                                                              1998          1999           2000
                                                                            --------      --------      ---------
<S>                                                                         <C>           <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................     $  2,590      $  6,924      $  14,834
Adjustments to reconcile net income to net cash
   Provided by (used in) operating activities
   Depreciation and amortization ......................................        4,693         5,898          6,039
   Provision for (reduction of) accounts receivable valuation reserves           (64)          234           (311)
   Loss on disposal of assets .........................................           --            --             74
   Tax benefit on stock option exercises ..............................           --            30            674
   Provision (benefit) from deferred taxes, net .......................        2,414           (15)          (320)
   Changes in assets and liabilities:
      (Increase) decrease in accounts receivable ......................       (5,997)       (2,519)        (2,438)
      (Increase) decrease in inventories ..............................       (4,238)          149         (8,172)
      (Increase) decrease in other assets .............................       (1,425)        1,272           (941)
      Increase (decrease) in accounts payable and accrued liabilities .        1,730         5,654         (2,567)
      Increase (decrease) in taxes payable ............................          235           807           (803)
                                                                            --------      --------      ---------
         Net cash provided by (used in) operating activities ..........          (62)       18,434          6,069
                                                                            --------      --------      ---------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment .............................       (8,119)      (12,537)        (8,807)
Purchase of investments ...............................................           --            --       (738,888)
Proceeds from maturities/sales of investments .........................           --            --        667,659
Investment in Inviso, Inc. ............................................       (3,320)           --           (500)
                                                                            --------      --------      ---------
         Net cash used in investing activities ........................      (11,439)      (12,537)       (80,536)
                                                                            --------      --------      ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) notes payable to banks ................        8,095        (8,095)         2,706
Stock options and warrants exercised ..................................           65           226          1,480
Purchase of treasury stock ............................................       (8,072)           --         (4,623)
Net proceeds from equity offering .....................................           --        42,390        128,658
                                                                            --------      --------      ---------
         Net cash provided by financing activities ....................           88        34,521        128,221
                                                                            --------      --------      ---------

Effect of exchange rate changes on cash and cash equivalents ..........          (12)           (1)          (241)
                                                                            --------      --------      ---------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................      (11,425)       40,417         53,513
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ..........................       16,371         4,946         45,363
                                                                            --------      --------      ---------
CASH AND CASH EQUIVALENTS, END OF YEAR ................................     $  4,946      $ 45,363      $  98,876
                                                                            ========      ========      =========

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid .........................................................     $    364      $    914      $     751
                                                                            ========      ========      =========
Income taxes paid, net of refunds .....................................     $    992      $  2,209      $   6,197
                                                                            ========      ========      =========

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Value of warrants granted .............................................     $     --      $    555      $      --
                                                                            ========      ========      =========
</TABLE>

              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                      F-6
<PAGE>   47
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1998, 1999 AND 2000

(1) ORGANIZATION AND OPERATIONS:

         Three-Five Systems, Inc. (a Delaware corporation) and subsidiaries (the
Company) offers advanced design and manufacturing services to a wide range of
original equipment manufacturers (OEMs). Most of the Company's sales consist of
custom display modules developed in close collaboration with its customers.
Devices designed and manufactured by the Company find application in
communication devices as well as in office, industrial, medical and commercial
electronics products. The Company currently specializes in liquid crystal
display (LCD) components and technology in providing its design and
manufacturing services for its customers. The Company markets its services
primarily in North America, Europe, and Asia through direct technical sales
persons and, to a much lesser extent, through an independent sales and
distribution network. The Company currently conducts manufacturing operations in
Tempe, Arizona; Manila, the Philippines; and Beijing, China. High-volume LCD
module manufacturing is done in Manila, the Philippines and Beijing, China.

         Three-Five Systems Limited (Limited), a wholly owned subsidiary of the
Company, is incorporated in the United Kingdom. Limited sells and distributes
the Company's products to customers on the European continent.

         Three-Five Systems Pacific, Inc. (Pacific), a wholly owned Philippines
corporation, manufactures the Company's products. Pacific also manages and
assists production personnel of a third-party subcontractor that operates the
facility in the Philippines.

         Three-Five Systems (Beijing) Co., Ltd. (Beijing), a wholly owned
subsidiary of the Company, manufactures and sells the Company's products to
customers primarily located in Asia.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

   Principles of Consolidation and Preparation of Financial Statements

         The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated.

         The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

   Concentration of Credit Risk

         The Company's strategy involves concentrating its efforts on providing
design and production services to leading companies in a limited number of
fast-growing industries. The Company has been undertaking substantial efforts to
diversify its business, broaden its customer base, and expand its markets.
Product sales for the Company's historical major customer accounted for
approximately 64%, 86%, and 87% of the Company's net sales in 1998, 1999, and
2000, respectively. This increased percentage occurred as a result of increased
sales to that customer as well as decreased sales to other customers. Since
1998, no other customer has accounted for more than 10% of the Company's net
sales. A significant decrease in orders for the Company's products from the
Company's historical major customer or a decline in the cellular telephone
industry would result in a material adverse impact on the Company's results of
operations and financial position.


                                      F-7
<PAGE>   48
         The significant amount of sales to a few customers results in certain
concentrations of credit risk for the Company. The Company's accounts receivable
balance, including the accounts receivable from the Company's largest customers,
is comprised of customers primarily in the cellular telephone, computer
hardware, and other electronic products industries. These customers are located
primarily in the United States, Asia and Europe.

   Fair Value of Financial Instruments

         The estimated fair value of financial instruments has been determined
by the Company using available market information and valuation methodologies.
Considerable judgment is required in estimating fair values. Accordingly, the
estimates may not be indicative of amounts that would be realized in a current
market exchange. The carrying values of cash, accounts receivable, and accounts
payable approximate fair value due to the short maturities of these instruments.
In addition, at December 31, 2000, the carrying amount on the outstanding
revolving line of credit facility is estimated to approximate fair value as the
actual interest rate is consistent with rates estimated to be currently
available for debt with similar terms and remaining maturities.

   Cash and Cash Equivalents

         For purposes of the statements of cash flows, all highly liquid
investments with a maturity of three months or less at the time of purchase are
considered to be cash equivalents. Cash equivalents consist of investments in
commercial paper, marketable debt securities, money market mutual funds, and
United States government agencies' obligations. A portion of the Company's funds
held in money market mutual funds are invested in repurchase agreements. These
repurchase agreements are collateralized by U.S. Treasury and Government
obligations. Cash equivalents consist of the following at (in thousands):

<TABLE>
<CAPTION>
                                                       December 31,
                                                   -------------------
                                                    1999        2000
                                                   -------     -------
<S>                                                <C>         <C>
          Cash and cash equivalents:
             Cash                                  $ 2,401     $ 3,686
             Commercial paper                       23,868      46,019
             Certificates of deposit                    --       4,119
             Money market                           19,094      30,553
             U.S. government agency securities          --       3,062
             Corporate notes and bonds                  --      11,437
                                                   -------     -------
                                                   $45,363     $98,876
                                                   =======     =======
</TABLE>

   Investments

         Short-term investments generally mature between four months and one
year from the purchase date. Debt securities with remaining maturities greater
than one year are classified as long-term investments. All short-term and
long-term investments are classified as available for sale and are presented at
market value using the specific identification method. Unrealized gains and
losses are reflected in other comprehensive income. Realized gains and losses
are included in results of operations. Cost approximates market for all
classifications of short-term and long-term investments. Unrealized gains and
losses were not material for all periods presented. Short-term and long-term
investments consist of the following at (in thousands):

<TABLE>
<CAPTION>
                                                      December 31,
                                                   -----------------
                                                    1999      2000
                                                   ------    -------
<S>                                                <C>       <C>
           Short-term investments:
              Certificates of deposit               $ --     $ 7,183
              Corporate notes and bonds               --      45,889
              U.S. government agency securities       --      13,623
                                                    ----     -------
                                                    $ --     $66,695
                                                    ====     =======
</TABLE>



                                      F-8
<PAGE>   49
<TABLE>
<CAPTION>
                                                   December 31,
                                                -----------------
                                                 1999       2000
                                                ------     ------
<S>                                             <C>        <C>
               Long-term investments:
                  Corporate notes and bonds     $  --      $4,534
                                                ------     ------
                                                $  --      $4,534
                                                ======     ======
</TABLE>

   Inventories

         Inventories are stated at the lower of cost (first-in, first-out) or
net realizable value and consist of the following at (in thousands):

<TABLE>
<CAPTION>
                                           DECEMBER 31,
                                        -------------------
                                         1999        2000
                                        -------     -------
<S>                                     <C>         <C>
                    Raw materials ....  $ 9,554     $15,898
                    Work-in-process ..    1,336       1,904
                    Finished goods ...    1,454       2,714
                                        -------     -------
                                        $12,344     $20,516
                                        =======     =======
</TABLE>

   Property, Plant and Equipment

         Property, plant and equipment is recorded at cost and generally is
depreciated using the straight-line method over the estimated useful lives of
the respective assets, which range from three to 39 years. Major additions and
betterments are capitalized, while replacements, maintenance and repairs that do
not extend the useful lives of the assets are charged to operations as incurred.
Depreciation expense totaled $4,653,000, $5,860,000, and $6,024,000 for the
years ended December 31, 1998, 1999 and 2000, respectively. During 1996, the
Company placed into service a high-volume LCD manufacturing line in its Tempe,
Arizona manufacturing facility. The Company is depreciating the LCD
manufacturing line using the units of production method. Depreciation expense
recorded using this method may be subject to significant fluctuation from year
to year resulting from changes in actual production levels and ongoing analysis
of the capacity of the equipment. Property, plant and equipment consist of the
following at (in thousands):

<TABLE>
<CAPTION>
                                                  DECEMBER 31,
                                             ----------------------
                                               1999          2000
                                             --------      --------
<S>                                          <C>           <C>
           Building and improvements ......  $ 16,411      $ 16,426
           Furniture and equipment ........    47,036        53,762
                                             --------      --------
                                               63,447        70,188
           Less accumulated depreciation ..   (22,901)      (26,934)
                                             --------      --------
                                             $ 40,546      $ 43,254
                                             ========      ========
</TABLE>

         During 1996, the Company entered into a transaction, in which it
conveyed its Tempe, Arizona facility and certain improvements to the City of
Tempe as consideration for a rent-free 75-year lease. The Company has the option
to repurchase the facility for $1,000 after ten years; therefore, the lease is
accounted for as a capital lease.

   Other Assets

         Other assets consist primarily of an investment, at cost, in a start-up
company in the display industry.

   Accrued Liabilities

         Accrued liabilities include accrued compensation of approximately
$3,788,000 and $2,849,000 at December 31, 1999 and 2000, respectively.


                                      F-9
<PAGE>   50
   Income Taxes

         Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, requires the
use of an asset and liability approach in accounting for income taxes. Deferred
tax assets and liabilities are recorded based on the differences between the
financial statement and tax bases of assets and liabilities and the tax rates in
effect when these differences are expected to reverse.

   Foreign Currency Translation

         Financial information relating to the Company's foreign subsidiaries is
reported in accordance with SFAS No. 52, Foreign Currency Translation. The
functional currency of Pacific is the same as the local currency. The gain or
loss resulting from the translation of Pacific's financial statements has been
included as a separate component of stockholders' equity. Non-U.S. assets and
liabilities are translated into U.S. dollars using the year-end exchange rates.
Revenues and expenses are translated at average rates during the year.

         The functional currency of Beijing and Limited is the U.S. dollar.
Beijing, however, maintains its books and records in the Renminbi. Therefore,
the Company utilizes the remeasurement method of foreign currency translation
when Beijing is consolidated. Any resulting remeasurement gain or loss is
reported in the Company's consolidated statements of operations.

         The net foreign currency transaction loss in 1998, 1999, and 2000 was
$177,000, $49,000, and $96,000, respectively, and has been included in other
expenses in the accompanying statements of income.

   Revenue Recognition

         The Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and
collectability is probable. Generally, all of these conditions are met at the
time the Company ships products to customers. The Company performs ongoing
credit evaluations of all of its customers and considers various factors in
establishing its allowance for doubtful accounts and sales returns and
allowances, which amounted to $750,000 and $439,000 at December 31, 1999 and
2000, respectively.

   Research, Development and Engineering

         Research, development and engineering costs are expensed as incurred.

   Earnings Per Share

         Basic earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock outstanding during the
year. Diluted earnings per common share are determined assuming that outstanding
options and warrants were exercised at the beginning of each year or at the time
of issuance, if later. Set forth below are the disclosures required pursuant to
SFAS No. 128 - Earnings Per Share:

<TABLE>
<CAPTION>
                                                           YEARS ENDED
                                                           DECEMBER 31,
                                               -----------------------------------
                                                1998          1999          2000
                                               -------       -------       -------
                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                           <C>            <C>           <C>
 Basic earnings per share:
 Income available to common stockholders .     $ 2,590       $ 6,924       $14,834
                                               -------       -------       -------
    Weighted average common shares .......      15,277        15,563        20,457
                                               -------       -------       -------
       Basic per share amount ............     $  0.17       $  0.44       $  0.73
                                               =======       =======       =======
 Diluted earnings per share:
 Income available to common stockholders .     $ 2,590       $ 6,924       $14,834
                                               -------       -------       -------
    Weighted average common shares .......      15,277        15,563        20,457
    Options and warrants assumed exercised         327           442         1,179
                                               -------       -------       -------
    Total common shares plus common
      stock equivalents ..................      15,604        16,005        21,636
                                               -------       -------       -------
       Diluted per share amount ..........     $  0.17       $  0.43       $  0.69
                                               =======       =======       =======
</TABLE>


                                      F-10
<PAGE>   51
  Recently Issued Accounting Standards

         In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. In June 1999, the FASB issued SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB No. 133. In June 2000, the FASB issued SFAS No. 138,
Accounting for Certain Derivative Instruments and Certain Hedging Activities, an
amendment of SFAS No. 133. SFAS No. 133, as amended, establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
No. 133 requires that changes in the derivative instrument's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative instrument's
gains and losses to offset related results on the hedged item in the income
statement, to the extent effective, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133, as amended, is effective for fiscal years
beginning after June 15, 2000. SFAS No. 133 cannot be applied retroactively. The
Company plans to adopt SFAS No. 133 on January 1, 2001.

         The Company has certain receivables denominated in Chinese Renminbi. To
eliminate its exposure to changes in the U.S. dollar/Chinese Renminbi exchange
rate, the Company has entered into forward contracts to protect its future cash
flows. Hedge accounting under current accounting principles generally accepted
in the United States does not require the Company to record any gain or loss on
the forward contracts until settled. In contrast, under SFAS No. 133 the Company
will designate the forward contracts as cash flow hedges. The Company will
account for changes in the fair value of its forward contracts, based on changes
in the forward exchange rate, with all changes in fair value reported in other
comprehensive income. Amounts in other comprehensive income will be reclassified
into earnings upon settlement of the forward contract at an amount that will
offset the related transaction gain or loss arising from the remeasurement and
adjust earnings for the cost of the forward contracts.

         In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101), which addresses certain criteria for revenue recognition. SAB 101, as
amended by SAB 101A and SAB 101B, outlines the criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. The Company has implemented the applicable provisions of
SAB 101. The impact of adopting the provisions of SAB 101 was not material to
the accompanying financial statements.

   In July 2000, the Emerging Issues Task Force (EITF) reached a final consensus
on Issue No. 00-10, Accounting for Shipping and Handling Fees and Costs. When
adopted, EITF No. 00-10 requires that all amounts billed to customers in sale
transactions related to shipping and handling be classified as revenue. The
Company adopted EITF No. 00-10 during its quarter ended September 30, 2000. The
impact of the adoption was not material to the accompanying financial statements
for any period presented.

         During March 2000, the FASB issued FASB Interpretation No. 44,
Accounting for Certain Transactions involving Stock Compensation - an
interpretation of APB Opinion No. 25 (FIN 44), which, among other issues,
addresses repricing and other modifications made to previously issued stock
options. The Company adopted FIN 44 during July 2000. The adoption of FIN 44 did
not have a material impact on the Company's financial position or results of
operations.

(3) DEBT:

         Borrowing under line of credit and term loan agreements were as follows
at (in thousands):

<TABLE>
<CAPTION>
                                                                                   DECEMBER 31,
                                                                                -----------------
                                                                                 1999       2000
                                                                                ------     ------
<S>                                                                             <C>        <C>
$25.0 million revolving line of credit, interest due monthly at the bank's
   prime rate (9.5% at December 31, 2000) or at the LIBOR base rate (5.95%
   at December 31, 2000) plus 1.5%,
   unpaid balance due January 19, 2001 ....................................     $   --     $   --

$2.706 million loan due Bank of China, interest due quarterly at 5.85%, due
   May 4, 2001, secured by a $3.0 million stand-by letter of credit issued
   under the $25.0 million revolving line of credit .......................         --      2,706

$350,000 United Kingdom credit facility, interest due quarterly at the
   bank's base rate plus 2%, unpaid balance due January 15, 2002,
   secured by Limited's accounts receivable ...............................         --         --
                                                                                ------     ------
                                                                                $   --     $2,706
                                                                                ======     ======
</TABLE>


                                      F-11
<PAGE>   52
     On January 21, 2000, the Company entered into a $25.0 million unsecured
revolving line of credit with Imperial Bank, which matures on January 19, 2001.
Mellon Bank is a participating lender on that credit facility. This line of
credit bears interest at the lower of the bank's prime rate, or at the LIBOR
base rate plus 1.5%, and is payable monthly. The revolving line of credit
contains restrictive covenants that include, among other things, restrictions on
the declaration or payment of dividends and the sale or transfer of assets. The
revolving line of credit facility also requires the Company to maintain a
specified net worth, as defined, to maintain a required debt to equity ratio,
and to maintain certain other financial ratios. The Company has renewed its
unsecured revolving line of credit with Imperial Bank through January 31, 2002.
The maximum borrowing on the revolving line of credit was reduced from $25.0
million to $15.0 million. All other terms of the agreement remains substantially
the same as described above.

(4) STOCKHOLDERS' EQUITY:

     In July 1999, the Company purchased certain assets and licensed silicon
technologies from National Semiconductor relating to liquid crystal on silicon
(LCoS(TM)) microdisplays for approximately $3.0 million in cash and warrants,
with a fair market value of $555,000 as determined by the Black-Scholes option
pricing method, to purchase 140,000 shares of common stock at a price of $8.47
per share, which was the closing price of the Company's common stock at the
grant date. The Company issued 102,014 shares of common stock upon exercise of
the warrants and the remaining 37,986 shares were used to effect the exercise on
December 20, 2000.

     In September 1999, the Company issued 4,000,226 shares of common stock
at $9.69 per share (the "1999 Offering"). The 1999 Offering consisted of
4,600,000 shares of common stock comprised of 2,068,686 newly issued Company
shares, 1,931,540 shares issued from treasury, and 599,774 shares sold by an
existing shareholder. In October 1999, the Company issued 690,000 shares of
common stock at $9.69 per share to cover over-allotments pertaining to the 1999
Offering. Expenses for the 1999 Offering totaled $3,007,000.

     On November 8, 1999, the Board of Directors approved a four-for-three
stock split, effective in the form of a 33 percent stock dividend. The stock
split was paid on December 17, 1999, to stockholders of record at the close of
business on December 3, 1999. This stock split has been given retroactive
recognition for all periods presented in the accompanying consolidated financial
statements.

     On April 18, 2000, the Board of Directors approved a three-for-two
stock split, to be effected in the form of a 50 percent stock dividend. The
Board's approval of the stock split was contingent upon the approval by the
stockholders of an increase in the number of authorized shares of common stock,
which occurred on April 27, 2000. At that time, the stockholders approved an
increase in the number of authorized shares of the Company's common stock from
15 million to 60 million. The stock dividend was paid on May 12, 2000, to
stockholders of record at the close of business on May 1, 2000. The increase in
the authorized shares and the stock split have been given retroactive
recognition for all periods presented in the accompanying consolidated financial
statements.

     In May 2000, the Company issued 2,150,000 shares of common stock at
$55.00 per share (the "2000 Offering"). In June 2000, the Company issued 322,500
shares of common stock at $55.00 per share to cover over-allotments pertaining
to the 2000 Offering. Expenses for the 2000 Offering totaled $7,341,000.

     On December 7, 2000, the Company's Board of Directors authorized a stock
repurchase program whereby the Company, at the discretion of management, could
buy back up to $30.0 million of its common stock in the open market. During the
year ended December 31, 2000, the Company purchased 241,381 shares at a cost of
$4,623,000.


                                      F-12
<PAGE>   53
(5) BENEFIT PLANS:

         The Company has five stock option plans, the 1990 Stock Option Plan
(1990 Plan), the 1993 Stock Option Plan (1993 Plan), the 1994 Non-Employee
Directors Stock Option Plan (1994 Plan), the 1997 Stock Option Plan (1997 Plan),
and 1998 Stock Option Plan (1998 Plan).

   1990 Stock Option Plan

         Under the 1990 Plan, there were options issued but unexercised to
purchase 118,364 shares as of December 31, 2000. In conjunction with stockholder
approval of the 1993 Plan, the Board terminated the 1990 Plan with respect to
unissued options to purchase 170,909 shares of common stock, which remained and
were unissued as of the date the 1993 Plan was adopted. The 1990 Plan expired on
May 1, 2000.

         The expiration date, maximum number of shares purchasable, and the
other provisions of the options granted under the 1990 Plan were established at
the time of grant. Options were granted for terms of up to ten years and become
exercisable in whole or in one or more installments at such times as were
determined by the Board of Directors upon grant of the options.

   1993 Stock Option Plan

         The 1993 Plan provides for the granting of options to purchase up to
770,909 shares of the Company's common stock (which includes 170,909 shares
previously reserved for issuance under the Company's 1990 Plan), the direct
granting of common stock (stock awards), the granting of stock appreciation
rights (SARs) and the granting of other cash awards (cash awards; stock awards,
SARs, and cash awards are collectively referred to herein as Awards). Under the
1993 Plan, options and Awards may be issued to key personnel and others
providing valuable services to the Company. The options issued may be incentive
stock options or nonqualified stock options. If any option or SAR terminates or
expires without having been exercised in full, stock not issued under such
option or SAR will again be available for grant pursuant to the 1993 Plan. There
were options outstanding to acquire 584,429 shares of the Company's common stock
under the 1993 Plan at December 31, 2000.

         To the extent that granted options are incentive stock options, the
terms and conditions of those options must be consistent with the qualification
requirement set forth in the Internal Revenue Code of 1986 (the Code). The
expiration date, maximum number of shares purchasable, and the other provisions
of the options will be established at the time of grant. Options may be granted
for terms of up to ten years and become exercisable in whole or in one or more
installments at such time as may be determined by the plan administrator upon
grant of the options. The exercise prices of options are determined by the plan
administrator, but may not be less than 100% (110% if the option is an incentive
stock option granted to a stockholder who at the time the option is granted owns
stock representing more than 10% of the total combined voting power of all
classes of stock of the Company) of the fair market value of the common stock at
the time of the grant. The 1993 Plan will remain in force until February 24,
2003.

   1994 Non-Employee Directors Stock Option Plan

         During 1999, the Board of Directors amended the 1994 Plan to decrease
the number of available shares for issuance from 200,000 shares to 100,000
shares.

         The 1994 Plan provides for the automatic grant of stock options to
non-employee directors to purchase up to 100,000 shares of the Company's common
stock. Under the 1994 Plan, options to acquire 500 shares of common stock will
be automatically granted to each non-employee director at the meeting of the
Board of Directors held immediately after each annual meeting of stockholders,
with such options to vest in a series of 12 equal and successive monthly
installments commencing one month after the annual automatic grant date. In
addition, each non-employee director serving on the Board of Directors on the
date the 1994 Plan was approved by the Company's stockholders received an
automatic grant of options to acquire 1,000 shares of common stock and each
subsequent newly elected non-employee member of the Board of Directors receives
an automatic grant of options to acquire 1,000 shares of common stock on the
date of their first appointment or election to the Board of Directors. Those
options become exercisable and vest in a series of three equal and successive
annual installments, with the first such


                                      F-13
<PAGE>   54
installment becoming exercisable immediately after the director's second
successive election to the Board of Directors (the First Vesting Date), the
second installment becoming exercisable 10 months after the First Vesting Date,
and the third installment becoming exercisable 22 months after the First Vesting
Date (provided that the director has not ceased serving as a director prior to a
vesting date). A non-employee member of the Board of Directors is not eligible
to receive the 500 share automatic option grant if that option grant date is
within 30 days of such non-employee member receiving the 1,000 share automatic
option grant. The exercise price per share of common stock subject to options
granted under the 1994 Plan will be equal to 100% of the fair market value of
the Company's common stock on the date such options are granted. There were
outstanding options to acquire 25,264 shares of the Company's common stock under
the 1994 Plan at December 31, 2000.

   1997 Stock Option Plan

         On January 27, 2000, the Board of Directors increased the number of the
Company's common stock available for issuance under the 1997 Plan from 200,000
to 350,000 shares. On August 3, 2000, the Board of Directors increased the
number of the Company's common stock available for issuance under the 1997 Plan
from 350,000 shares to 650,000 shares.

   The 1997 Plan provides for the granting of nonqualified options. Under the
1997 Plan, options may be issued to key personnel and others providing valuable
services to the Company. The options issued will be nonqualified stock options
and shall not be incentive stock options as defined in Section 422 of the Code.
Any option that expires or terminates without having been exercised in full will
again be available for grant pursuant to the 1997 Plan. There were options
outstanding to acquire 485,897 shares of the Company's common stock under the
1997 Plan at December 31, 2000.

         The expiration date, maximum number of shares purchasable, and the
other provisions of the options will be established at the time of grant.
Options may be granted for terms of up to ten years and become exercisable in
whole or in one or more installments at such time as may be determined by the
plan administrator upon grant of the options. The exercise prices of the options
are determined by the plan administrator, but may not be less than 100% of the
fair market value of the common stock at the time of the grant. The 1997 Plan
will remain in force until May 12, 2007.

   1998 Stock Option Plan

         During 1999, the stockholders approved an amendment to the 1998 Plan to
increase the number of shares of the Company's common stock that may be issued
from 600,000 shares to 1,100,000 shares.

         The 1998 Plan provides for the granting of incentive stock options
and/or nonqualified options. Under the 1998 Plan, options may be issued to key
personnel and others providing valuable services to the Company. The options
issued will be incentive stock options or nonqualified stock options as defined
in Section 422 of the Code. Any option that expires or terminates without having
been exercised in full will again be available for grant pursuant to the 1998
Plan. There were options outstanding to acquire 760,639 shares of the Company's
common stock under the 1998 Plan at December 31, 2000.

         The expiration date, maximum number of shares purchasable, and the
other provisions of the options will be established at the time of grant.
Options may be granted for terms of up to ten years and become exercisable in
whole or in one or more installments at such time as may be determined by the
plan administrator upon grant of the options. The exercise prices of the options
are determined by the plan administrator, but may not be less than 100% of the
fair market value of the common stock at the time of the grant (110% if the
option is an incentive stock option granted to a stockholder who at the time the
option is granted owns stock representing more than 10% of the total combined
voting power of all classes of stock of the Company). The 1998 Plan will remain
in force until January 28, 2008.

         Tax benefits from option exercises are credited to additional paid-in
capital.

         A summary of the status of the Company's five stock option plans at
December 31, 1998, 1999, and 2000 and changes during the years then ended, are
presented in the table and narrative below:


                                      F-14
<PAGE>   55
<TABLE>
<CAPTION>
                                               1998                    1999                       2000
                                     ----------------------   ----------------------     ----------------------
                                                   WEIGHTED                 WEIGHTED                   WEIGHTED
                                                   AVERAGE                  AVERAGE                     AVERAGE
                                                   EXERCISE                 EXERCISE                   EXERCISE
                                      OPTIONS       PRICE      OPTIONS        PRICE       OPTIONS        PRICE
                                     ----------    --------   ----------    --------     ----------    --------
<S>                                  <C>           <C>        <C>           <C>          <C>           <C>
Outstanding at beginning
    of year .......................  1,110,050      $5.54     1,399,750       $6.10      1,737,397       $ 7.76
Granted ...........................    669,722       6.93     1,021,957        8.51        528,798        33.95
Exercised .........................    (94,047)       .54      (157,475)       1.94       (228,063)        7.46
Expired ...........................   (285,975)      7.72      (526,835)       6.56        (63,539)        9.58
                                     ---------                ---------                  ---------
Outstanding at end of year ........  1,399,750      $6.10     1,737,397       $7.76      1,974,593       $14.75
                                     =========                =========                  =========

Exercisable at end of year ........    455,086      $4.99       447,707       $6.73        485,050       $ 7.12
                                     =========      =====     =========       =====      =========       ======

Weighted average fair value of
  options granted .................                 $5.13                     $6.54                      $27.24
                                                    =====                     =====                      ======
</TABLE>

         The following table summarizes information about stock options
outstanding at December 31, 2000:

<TABLE>
<CAPTION>
                      OPTIONS OUTSTANDING                               OPTIONS EXERCISABLE
---------------------------------------------------------------     ---------------------------
                          NUMBER         WEIGHTED                     NUMBER
                       OUTSTANDING       AVERAGE       WEIGHTED     EXERCISABLE        WEIGHTED
   RANGE OF                 AT          REMAINING      AVERAGE          AT             AVERAGE
   EXERCISE            DECEMBER 31,    CONTRACTUAL     EXERCISE     DECEMBER 31,       EXERCISE
    PRICES                 2000           LIFE          PRICE          2000             PRICE
   --------            ------------    -----------     --------     ------------       --------
<S>                    <C>             <C>             <C>          <C>                <C>
$ 0.32 - $7.46             698,572          6.4         $ 5.88        369,524           $ 5.85
  7.47 - 14.93             731,142          8.4           9.37        110,131             9.55
 14.94 - 74.63             544,879          9.3          33.33          5,395            44.51
                         ---------        -----         ------        -------           ------
                         1,974,593          8.0         $14.75        485,050           $ 7.12
                         =========        =====         ======        =======           ======
</TABLE>

         Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company accounts for transactions with its employees pursuant
to Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued
to Employees, under which no compensation cost has been recognized. However, the
Company has computed, for pro forma disclosure purposes, the value of all
options granted during 1998, 1999, and 2000, using the Black-Scholes option
pricing method with the following weighted assumptions: risk-free interest rates
of 4.52%, 6.34%, and 4.75%; expected dividend yields of zero; expected lives of
6.6, 6.2, and 6.2 years; and expected volatility (a measure of the amount by
which a price has fluctuated or is expected to fluctuate during a period) of
61.4%, 61.9%, and 72.6%. Had compensation cost for these plans been determined
consistent with SFAS No. 123, the Company's net income and earnings per share
would have been as follows:

<TABLE>
<CAPTION>
                                            YEARS ENDED DECEMBER 31,
                                     --------------------------------------
                                        1998          1999          2000
                                     ----------    ----------    ----------
                                                 (IN THOUSANDS,
                                             EXCEPT PER SHARE DATA)
<S>                                  <C>           <C>           <C>
     Net income:
          As reported ..........     $    2,590    $    6,924    $   14,834
          Pro forma ............          1,980         5,423        13,000

     Basic earnings per share:
          As reported ..........     $     0.17    $     0.44    $     0.73
          Pro forma ............           0.13          0.35          0.64

     Diluted earnings per share:
          As reported ..........     $     0.17    $     0.43    $     0.69
          Pro forma ............           0.13          0.34          0.60
</TABLE>



                                      F-15
<PAGE>   56
   401(k) PROFIT SHARING PLAN

         The Company has adopted a profit sharing plan (401(k) Plan) pursuant to
Section 401(k) of the Code. The 401(k) Plan covers substantially all full-time
employees who meet the eligibility requirements and provides for a discretionary
profit sharing contribution by the Company and an employee elective contribution
with a discretionary Company matching provision. The Company expensed
discretionary contributions pursuant to the 401(k) Plan in the amount of
$100,000, $159,000, and $207,000 for the years ended December 31, 1998, 1999,
and 2000, respectively.

(6) INCOME TAXES:

         The provision (benefit) for income taxes for the years ended December
31 consists of the following (in thousands):

<TABLE>
<CAPTION>
                                                                1998         1999         2000
                                                               -------      -------      -------
<S>                                                            <C>          <C>          <C>
Current provision (benefit), net of tax credits utilized:
   Federal, net of tax benefit from stock option exercises     $  (509)     $ 2,619      $ 4,641

   States ................................................         (24)         210           45
   Foreign ...............................................         237          832          780
                                                               -------      -------      -------
                                                                  (296)       3,661        5,466
   Deferred provision (benefit) ..........................       2,069         (723)        (626)
   Tax benefit from stock option exercises ...............          --           30          674
                                                               -------      -------      -------
          Provision for income taxes .....................     $ 1,773      $ 2,968      $ 5,514
                                                               =======      =======      =======
</TABLE>

         In accordance with SFAS No. 109, tax credits of approximately $-0-,
$115,000, and $1,244,000 were utilized in 1998, 1999, and 2000, respectively,
and are included as a reduction of the current provision for income taxes in the
consolidated statements of income.

         The components of deferred taxes at December 31 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                       1999       2000
                                                      ------     ------
<S>                                                   <C>        <C>
Net long-term deferred tax liabilities:
   Accelerated tax depreciation .................     $3,229     $4,110
   Investments in foreign affiliates ............        463        377
                                                      ------     ------
                                                      $3,692     $4,487
                                                      ======     ======
Net short-term deferred tax assets:
   Uniform capitalization .......................     $  692     $1,071
   Accrued liabilities and reserves not currently      2,268      3,102
deductible
   Allowance for doubtful accounts ..............        233        150
   Other ........................................         38         23
                                                      ------     ------
                                                      $3,231     $4,346
                                                      ======     ======
</TABLE>

         A reconciliation of the U.S. federal statutory rate to the Company's
effective tax rate is as follows:

<TABLE>
<CAPTION>
                                               1998     1999      2000
                                               ----     ----      ----
<S>                                            <C>      <C>       <C>
Statutory federal rate ....................     34%      34%       35%
Effect of state taxes .....................      3        3         2
Foreign earnings taxed at different rates .     --       (4)       (5)
Other, net ................................      4        3        --
Benefit from prior year state refund claims     --       (6)       --
Credits for research and experiment .......     --       --        (5)
                                               ----     ----      ----
                                                41%      30%       27%
                                               ====     ====      ====
</TABLE>

         A deferred U.S. tax liability has not been provided on the
undistributed earnings of certain foreign subsidiaries because it is the intent
of the Company to permanently reinvest such earnings. Undistributed earnings of
foreign subsidiaries, which have been, or are intended to be, permanently
invested in accordance with APB No. 23, Accounting for Income Taxes - Special
Areas, aggregated approximately $990,000 and $4,288,000 at December 31, 1999 and
2000, respectively.


                                      F-16
<PAGE>   57
(7) COMMITMENTS AND CONTINGENCIES:

         In May 2000, Pacific signed a lease for a build-to-suit factory in
Manila. The term of the lease is 125 months starting upon the completion of the
factory expected to be by the end of the first quarter of 2001. The Company will
be employing its own employees at the build-to-suit factory and will not be
employing the services of the third-party subcontractor. In July 2000, the
Company exercised its right to terminate its sub-assembly agreement with its
third-party subcontractor in Manila. The Company is negotiating with its
third-party subcontractor and intends to have in place a new sub-assembly
agreement by the end of the first quarter of 2001. The third-party subcontractor
operates a facility utilizing equipment, processes, and documentation owned by
the Company. The inability of the Company to obtain products pursuant to the new
sub-assembly agreement, even for a relatively short period, would have a
material adverse effect on the operations and profitability of the Company.

         In April 1994, the Company entered into a ground lease (with purchase
options) on a 5.7 acre site in Tempe, Arizona. Annual lease payments under the
ground lease, which will expire on March 31, 2069, subject to renewal and
purchase options as well as termination provisions, will average approximately
$100,000 over the term of the lease subject to certain escalation provisions. A
design, manufacturing, and corporate headquarters facility containing
approximately 97,000 square feet was completed on the land in 1995 at a cost of
approximately $10.4 million.

         The Company's future lease commitments under the non-cancelable
operating leases as of December 31, 2000 are as follows (in thousands):

<TABLE>
<S>                                                  <C>
                 2001 .............................  $   874
                 2002 .............................      924
                 2003 .............................      883
                 2004 .............................    1,040
                 Thereafter .......................   12,816
                                                     -------
                                                     $16,537
                                                     =======
</TABLE>

         Rent expense was approximately $917,000, $763,000, and $553,000 for the
years ended December 31, 1998, 1999, and 2000, respectively.

         The Company is involved in certain administrative proceedings arising
in the normal course of business. In the opinion of management, the ultimate
settlement of these administrative proceedings will not materially impact its
financial position or results of operations.

(8) SEGMENT INFORMATION:

         Management monitors and evaluates the financial performance of the
Company's operations by its four operating segments located throughout the
world. These segments consist of three manufacturing operations, located in the
United States, China, and the Philippines, and a sales and distribution
operation in the United Kingdom.

         The following operating segment information includes financial
information (in thousands) for all four of the Company's operating segments. The
accounting policies of the operating segments are the same as those described in
Note 2, Summary of Significant Accounting Policies. Financial information for
the China operation is presented beginning from the date those operations
commenced, June 1998.

<TABLE>
<CAPTION>
                                    UNITED       UNITED
                                    STATES       KINGDOM      CHINA      PHILIPPINES  ELIMINATIONS     TOTAL
                                    ------       -------      -----      -----------  ------------     -----
<S>                                <C>           <C>         <C>         <C>          <C>             <C>
DECEMBER 31, 1998
Net sales ....................     $ 92,251      $33,438     $  7,205      $ 3,010      $(40,857)     $95,047
Depreciation .................        4,408           36          168           41            --        4,653
Interest, net ................          (28)          95            5            3            --           75
Income (loss) before provision
   for income taxes ..........        4,643          676         (947)          (2)           (7)       4,363
Provision for income taxes ...        1,537          209           --           27            --        1,773
Total assets .................       60,514        9,195       12,301          642        (4,748)      77,904
Capital expenditures .........        2,809           10        5,298            2            --        8,119
</TABLE>


                                      F-17
<PAGE>   58
<TABLE>
<CAPTION>
                                    UNITED       UNITED
                                    STATES       KINGDOM      CHINA      PHILIPPINES  ELIMINATIONS     TOTAL
                                    ------       -------      -----      -----------  ------------     -----
<S>                                <C>           <C>         <C>         <C>          <C>             <C>
DECEMBER 31, 1999
Net sales                          $134,028     $68,798     $ 40,257        $3,291     $(98,966)      $147,408
Depreciation                          4,983          21          856            --           --          5,860
Interest, net                             1          31           16             3           --             51
Income before provision for
   income taxes                       6,381       1,624        2,147            65         (325)         9,892
Provision for income taxes            2,140         811           --            17           --          2,968
Total assets                        101,562      10,421       19,235           696       (4,984)       126,930
Capital expenditures                  7,459           9        5,624            --           --         13,092
</TABLE>

<TABLE>
<CAPTION>
                                    UNITED       UNITED
                                    STATES       KINGDOM      CHINA      PHILIPPINES  ELIMINATIONS     TOTAL
                                    ------       -------      -----      -----------  ------------     -----
<S>                                <C>           <C>         <C>         <C>          <C>             <C>
DECEMBER 31, 2000
Net sales                          $143,115      $52,734     $43,515       $2,990      $(81,670)      $160,684
Depreciation                          4,930           17       1,077           --            --          6,024
Interest, net                         7,960          (39)       (556)           9            --          7,374
Income before provision for
   income taxes                      12,895        1,996       5,391           58             8         20,348
Provision for income taxes            4,735          757          --           22            --          5,514
Total assets                        242,718        8,582      18,342        2,513        (4,312)       267,843
Capital expenditures                  7,510           27         531          724            --          8,792
</TABLE>

         Net sales are generated from the sale of LCD display devices, which are
applied in several different end-use products.

(9) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

         The following table summarizes the unaudited consolidated quarterly
results of operations as reported for 1999 and 2000 (in thousands, except per
share amounts):

<TABLE>
<CAPTION>
                                                                 Quarters Ended
                        ---------------------------------------------------------------------------------------------
                                              1999                                           2000
                        ---------------------------------------------     -------------------------------------------
                        Mar. 31       June 30     Sep. 30     Dec. 31     Mar. 31     June 30     Sep. 30     Dec. 31
                        --------      -------     -------     -------     -------     -------     -------     -------
<S>                     <C>           <C>         <C>         <C>         <C>         <C>         <C>         <C>
Net sales               $ 23,044      $31,600     $42,723     $50,041     $39,162     $44,926     $40,231     $36,365
Gross profit               2,853        6,497       8,841      11,634       9,802      10,769       9,116       6,273
Net income (loss)           (642)       1,040       2,037       4,489       3,587       4,369       4,345       2,533

Earnings (loss) per
  Common share:
   Basic                $  (0.05)     $  0.07     $  0.14     $  0.24     $  0.19     $  0.22     $  0.20     $  0.12
                        --------      -------     -------     -------     -------     -------     -------     -------
   Diluted              $  (0.05)     $  0.07     $  0.14     $  0.23     $  0.18     $  0.21     $  0.19     $  0.11
                        --------      -------     -------     -------     -------     -------     -------     -------
</TABLE>


                                      F-18
<PAGE>   59
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Three-Five Systems, Inc.:

We have audited in accordance with auditing standards generally accepted in the
United States, the financial statements included in Three-Five Systems, Inc. and
subsidiaries' Form 10-K, and have issued our report thereon dated January 19,
2001. Our audit was made for the purpose of forming an opinion on those
statements taken as a whole. The schedule shown on page S-2 is the
responsibility of the Company's management and is presented for the purpose of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.


                                     /s/ARTHUR ANDERSEN LLP



Phoenix, Arizona
January 19, 2001


                                       S-1
<PAGE>   60
                    THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

                                   SCHEDULE II
                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000

<TABLE>
<CAPTION>
                                                               Increases
                                                              (Reductions)
                                                 Balance at    Charged to     Charged to
                                                 beginning     Costs and         Other                       Balance at
                                                 of Period      Expenses       Accounts       Write-offs    End of Period
                                                 ------------------------------------------------------------------------
                                                                            (in thousands)
<S>                                              <C>          <C>             <C>             <C>           <C>
Allowance for doubtful accounts and sales
  returns and allowances:
   Year ended 12/31/98                              $580         $ (24)          $(40)           $ --           $516
   Year ended 12/31/99                               516           219             --              15            750
   Year ended 12/31/00                               750          (316)            --               5            439
</TABLE>


                                       S-2
<PAGE>   61
                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER   EXHIBITS
-------  --------
<S>      <C>
2        Amended and Restated Agreement and Plan or Reorganization(1)

3(a)     Amended and Restated Certificate of Incorporation of the Company(2)

3(b)     Certificate of Amendment of Restated Certificate of Incorporation(3)

3(c)     Amended and Restated Bylaws of the Company(4)

4        Form of Certificate of Common Stock(4)

10(a)    Amended and Restated 1997 Employee Option Plan (as amended through
         August 2000)(5)

10(c)    Line of Credit Agreement between Three-Five Systems Limited and
         Barclays Bank, PLC(1)

10(g)    Form of Three-Five Systems, Inc. Distributor Franchise Agreement(6)

10(j)    1993 Stock Option Plan(6)

10(k)    1994 Automatic Stock Option Plan(7)

10(o)    Lease dated April 1, 1994, between Papago Park Center, Inc. and
         Three-Five Systems, Inc.(8)

10(v)    1997 Employee Stock Option Agreement(9)

10(w)    Amended and Restated Three-Five Systems, Inc. 1998 Stock Option Plan,
         amended as of January 28, 1999, as approved by the Company's
         stockholders on April 22, 1999(10)

10(x)    Amended and Restated Directors' Stock Plan(11)

10(z)    401(k) Profit Sharing Plan(12)

10(aa)   Credit Agreement dated January 21, 2000, by and among Three-Five
         Systems, Inc., its subsidiaries, the Banks named therein, and Imperial
         Bank Arizona, as Agent and as Issuing Bank(11)

10(cc)   Modification Agreement dated February 1, 2001, by and among Three-Five
         Systems, Inc., its subsidiaries, the Banks named in the Credit
         Agreement, and Imperial Bank as administrative agent and as Issuing
         Bank

21       List of Subsidiaries(4)

23       Consent of Arthur Andersen LLP
</TABLE>

(1)      Incorporated by reference to the Registration Statement on Form S-4 of
         TF Consolidation, Inc. (Registration No. 33-33944) as filed March 27,
         1990 and declared effective March 27, 1990.

(2)      Incorporated by reference to the Registrant's Form 10-QSB for the
         quarter ended March 31, 1994, as filed with the Commission on or about
         May 12, 1994.

(3)      Incorporated by reference to the Registrant's Form S-3/A as filed with
         the Commission on May 5, 2000.

(4)      Incorporated by reference to the Registration Statement on Form S-3
         (Registration No. 333-84083) as filed on July 30, 1999, as amended by
         Form S-3/A filed on August 26, 1999, and declared effective September
         27, 1999.

(5)      Incorporated by reference to the Registrant's Form S-8 as filed with
         the Commission on November 3, 2000.

(6)      Incorporated by reference to the Registration Statement on Form S-1
         (Registration No. 33-74788) as filed on February 3, 1994, and declared
         effective March 15, 1994.

(7)      Incorporated by reference to the Registration Statement on Form S-8
         (Registration No. 33-88706) as filed on January 24, 1995.

(8)      Incorporated by reference to the Registrant's Form 10-K for the fiscal
         year ended December 31, 1996, as filed with the Commission on March 14,
         1997.

(9)      Incorporated by reference to the Registrant's Form 10-K for the fiscal
         year ended December 31, 1997, as filed with the Commission on March 13,
         1998, and as amended by Form 10-K/A filed with the Commission on March
         23, 1998.

(10)     Incorporated by reference to the Registration Statement on Form S-8
         (Registration No. 333-87875) as filed on September 27, 1999.

(11)     Incorporated by reference to the Registrant's Form 10-Q for the quarter
         ended June 30, 2000, as filed with the Commission on July 27, 2000.

(12)     Incorporated by reference to the Registration Statement on Form S-8
         (Registration No. 333-57933) as filed on June 26, 1998.